Inflation that occurs

how inflation occurs

INTRODUCTION TO INFLATION

Inflation that occurs, as a result of an abnormal event in the price, is not an inflation. Therefore, inflation has two important features. They are:

  • Consistent rise in the price level and
  • The phenomena for a relatively longer period.

Definition:

According to crowther," A state in which the value of money is falling-that the prices are rising".

Annual inflation went up sharply in October to 1.34% from 0.5% a month earlier due to costlier food items, the data released on the

New monthly wholesale price index released. The accelerating inflation is expected to impart more urgency to monetary tightening if the economic recovery sustains.

Prices of key food items including wheat, rice etc. increased during the course of the month, though there was some let up in the prices of fruits and vegetables, which dropped a steep 11% during the course of the month. The built up inflation in the current year, or the increase in prices from the beginning of the current fiscal to end of October, has been strong at 6.13% against 5.99% in the corresponding prettied last year. Minerals and industrial fuels were up 3% each during the month while prices of manufactured products remained largely unchanged.

Inflation in India:

Inflation is an international phenomenon. This is true to somewhat extent in the present scenario. This is backed by the factors such as galloping international crude oil prices, inflow of foreign capital and so on.

Food prices have gone up sharply because of the poor monsoons, which has affected the production of both food grains and vegetables. Production of food grains is expected to drop 15 million tones in the current kharif season. However, late monsoon rains have improved the prospects for the Rabi crop, which should help bring down prices of food articles.

The factors responsible for inflation. Data on inflation for the last five years and analyze the trend:

Demand:

  1. Increase in nominal money supply: Increase in nominal money supply without corresponding increase in output increases the aggregate demand. The higher the money supply the higher will be the inflation.
  2. Increase in disposable income: When the disposable income of the people increases, their demand for goods and services also increases.
  3. Expansion of Credit: When there's expansion in credit beyond the safe limits, it creates increase in money supply, which causes the increased demand for goods and services in the economy. This phenomenon is also known as 'credit-induced inflation'.
  4. Deficit Financing Policy: Deficit financing raises aggregate demand in relation to the aggregate supply. This phenomenon is known as 'deficit financing-induced inflation'.
  5. Black money spending: People having black money spend money lavishly, which increases the demand un-necessarily, while supply remains unchanged and prices go up.

Supply:

  1. Shortage of factors of production or inputs: Shortage of factors of production, i.e. raw material, labour capital etc causes the reduced production, which causes the increase in prices.
  2. Industrial Disputes: When industrial disputes come to happen, i.e. trade unions resort strikes or employers decide lock outs etc the industrial production reduces. And as a short supply of goods in the market the prices go up.
  3. Artificial Scarcities: Hoarders, black marketers and speculators etc create artificial shortage to earn more profits by keeping the prices high. (in Pakistan bird flu dilemma and sugar crises are the major examples in this regard)
  4. Global factors: This factor includes the changing global environment. Most common example is the rise in oil prices. This factor of inflation may vary in nature, i.e. it can be political, strategic, economic or logistic in nature.
  5. Neglecting the production of consumer goods: When the production of consumer goods is neglected with reference to the increased production of luxuries, it also creates inflation. For example in Pakistan, in last couple of years our services sector has grown with the highest rate of 8.8% (mainly telecom sector), while basic necessities have been ignored which created increase in the prices of consumer goods.
  6. Application of law of diminishing returns: this law applies when the industries use old machines and methods and, which increase in cost by increasing the scale of production. This furthers the increase in prices and hence inflation bursts out.

India's annual food inflation rises to 14.55%

India's annual food inflation, based on wholesale prices, moved up to 14.55 per cent. The 52-week average prices of onions were higher by 35 per cent and potatoes became costlier by 30.7 per cent, according to the data on wholesale price index released by the commerce ministry. Statistics also showed average prices of vegetables had gone up 18 per cent, pulses 17 percent, rice 16 per cent, wheat 5 per cent, fruits 7 per cent and milk 8 percent.

Finance Minister Pranab Mukherjee Wednesday said here that the government may have to import rice if the kharif crop output was inadequate. Floods and the worst dry spell in nearly four decades in the country have hurt farm output causing rise in food prices.

This was the third week for which data on wholesale price index was issued as per the new guidelines approved by the Cabinet Committee on Economic Affairs that restricts the disclosure of index numbers to primary articles and fuels.

In a new system of reporting wholesale price index (WPI)-based inflation, the entire index will be reported only once a month now against every week earlier. However, the government will continue to report the index number for primary articles and fuels every week. This is expected to improve data quality, as more time will be available for collecting and validating data. The base year for the index, however, remains 1993-94.

The government is likely to announce a revamped wholesale price index from the next fiscal. The new index will have a larger and more current product basket and 2004-05 as the base year, making it more relevant for policymakers.

Commodity inflation

Analysis of current economic conditions and policy

A recent documents an increasing tendency for commodity prices to move together over the last few years. A decade ago, what happened to oil prices was largely unrelated to movements in most other commodity prices. The graphs below show how the correlations between oil prices and the prices of four representative commodities have increased significantly over time.

RESEARCH:

One explanation I often see in the popular press is that movements in commodity prices are driven by changes in the value of the dollar relative to other currencies. However, the magnitude of movements in commodity prices greatly exceeds the size of changes in the exchange

rate. For example, the table above shows that since the start of this year oil prices have increased five times as much as the dollar price of a euro; While the depreciation of the dollar is part of the story, most of the explanation must be found elsewhere.

Another important factor is resurging real economic growth outside the United States, which produces pressures for both the dollar to depreciate and the real price of commodities to appreciate. According to this theory, the increasing correlations between commodity prices results from the fact that countries like China are so much more important for the world economy today than they were a decade ago.

A third explanation is that investors are making increasing use of commodities as an investment class. Although Treasury Inflation Protected Securities offer a hedge against an increase in the U.S. consumer price index, they don't offer protection for foreign investors against depreciation of the dollar. Insofar as increases in the prices of commodities like oil may depress real economic activity, holding commodities as an investment also offers useful diversification against risks to equities. Particularly when interest rates are low, there is an incentive to hoard physical commodities as an investment vehicle.

The increased use of commodities as a financial investment accounts for the increasing correlation among commodity price changes over time. For example, one of the regressions they estimate relates the return on commodity i to equity returns, bond yields, the value of the dollar, and oil prices, where the coefficients are allowed to grow with time at different rates before and after 2004, and with different trends on these coefficients estimated for commodities included in indexes as for those excluded. The figure below shows their estimated time path for the coefficient on oil prices comparing the indexed and non-indexed groups.

For any of the explanations in this third class, one of the important challenges is to reconcile the story of commodity speculation with supply and demand for the underlying physical commodity. If we propose that speculators have driven the price of the commodity up, the physical quantity demanded should decline as a result. In order to be sustained, a coherent speculation-based theory of commodity price appreciation requires increased physical storage of the commodity.

The solid black curve in the figure below plots the typical U.S. crude oil stocks (excluding those held in the Strategic Petroleum Reserve) for each week of the year, based on the average over 1990-2007. The red line gives the actual values for 2008, which were significantly below the historical average, particularly in the spring of 2008 when oil prices were rising so dramatically. Those below-normal inventories were one reason I focused on what was going on to the fundamentals of supply and demand in trying to understand the behavior of oil markets in the first half of 2008.

On the other hand, inventories of crude oil this year, shown in green above, have been substantially above normal, meaning that in the absence of that oil going into storage, we would have expected to see lower oil prices than we currently have.

Everyone knows where the cheap money NEEDS to go, but the people in charge and many of those who advise them simply refuse to acknowledge that the mechanisms that would direct it there have been dismantled.

If speculators were to bid up the future price of oil in 2011, someone wishing to arbitrage the spread between that price and the spot price would need to find physical storage. But one form of storage, available to producers, is to simply to not pump the oil.

If speculators can raise the future price of oil, they could influence present production, and ipso facto the spot price, without the need for additional storage.

A logical conclusion of your two arguments (not in the same post) is that too much stimulus.

  1. too much liquidity leads to speculations that drives oil and commodity prices higher; and
  2. higher oil and commodity prices .

We are not talking only about the price that a real consumer pays for a real product that is physically consumed. If there is a futures market in the commodity a seller is not obligated to hold and store the quantity contracted for pending delivery. Many, I think most, outstanding contracts are sold by speculators who close out their positions with offsetting purchases before the delivery date. The futures markets, however, strongly influence the "physicals" or spot market price.

STEPS TAKEN BY RBI:

RBI(Reserve bank of India) has taken some steps regarding the inflation, these are following as under:

RBI survey of analysts sees FY10 GDP at 6%:

Economists and analysts surveyed by the Reserve Bank of India (RBI) revised downwards India's gross domestic product projection to 6.0 per cent for 2009/10 from 6.5 per cent in the previous round of survey.

The forecasters also assigned a highest 34.3 per cent chance for inflation to be within 6.0-6.9 per cent in 2009/10, the survey showed.

The RBI released the results of the ninth round of survey on Monday, adding that the result in no way reflects the views of the central bank.

The central bank polled 21 respondents for the survey which included macro-economic parameters like GDP, inflation, interest rates, money supply and credit growth.

The RBI in its mid-term monetary policy review had kept its GDP projection for the current fiscal unchanged at 6.0 per cent but had increased inflation target to 6.5 per cent by end-March 2010 from 5.0 per cent earlier.

The economists surveyed have sharply reduced their expectation for agriculture growth in 2009/10 to -1.4 per cent from 2.5 per cent projected in the previous round.

"For industry, the forecasts have been revised upwards from 4.8 per cent to 6.3 per cent whereas for the services sector, there was modest downward revision from 8.3 per cent in the earlier survey to 8.1 per cent in the current survey," RBI said.

The study also showed that the economists expect the Jul-Sep GDP growth at 6.2 per cent and for Oct-Dec and Jan-Mar at 5.7 per cent and 6.7 per cent respectively.

The government is scheduled to announce the Jul-Sep GDP growth number on Nov. 30.

The forecasters expect headline inflation to be at 4.0 per cent in Oct-Dec and at 6.8 per cent the following quarter.

Over the next five years, GDP is expected to grow at 7.5 per cent, unchanged from the previous round of survey, RBI said.

But inflation forecast over the next five years, was revised upwards to 5.5 per cent from 5.3 per cent in the previous survey.

Source: www.ukessays.com

Category: Bank

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