Module 5 Inflation
Definition of Inflation
Inflation is a situation where the value of money that is price are rising.Here prices of all goods
and services are rising. Rise in price is continuously. As there is no corresponding increase in
output and employment .
Types of Inflation
On the basis of intensity of price rise inflation is of four types.
Creeping Inflation-The rise in price ranges within 3% to 7%.It is safe for economic growth.
Trotting inflation or Walking inflation-If price rise is single digit in a year it is a warning for the govt.
to control inflation.
Running or Galloping inflation-The rise in price is between 10% to 20% which is a serious problem
for the economy.
Hyper Inflation-the rise in price level is more than galloping inflation.
Demand pull Inflation
When there is excess demand or available supply at existing price leads to increase in aggregate
demand ,supply remaining constant initially the price increases along with increase in output after
full employment is reached only price increase with increase in demand supply remaining constant.
Causes of demand pull inflation
• Increase in quantity of money supply-Resultant increase in money credit by banks increases
money supply leading to increase in price level.
• Increase in disposable income leads –When income increases it leads to increase in demand
for goods and services thus leading to consumption expenditure.
• Increase in consumption expenditure.-The demand for goods and services increases due to
demonstration effect when credit facility are given.
• Deficit financing-When money supply increases from central bank to commercial bank to
make economic development price level increases.
• Expansion of private section-Increase in private sectors increase income in the hand of
people increasing demand for goods thus leading to inflationary situation.
• Black money-This increases printing of notes leading to increase in money supply in
circulation and increases demand for goods.
• Increase in export- increase in export increases inflow of money to the country leading to
increase in price of goods.
Cost push inflation
Causes of cost push inflation
• Higher wage rate-this concept leads to wage push inflation.It is through the trade union
worker are able to achieve higher money wage through collective bargaining without a
corresponding increase in productivity causing an upward shape in aggregate supply through
increase in total cost.
• Higher profit margin-Sometimes monopolistic and oligopolistic producers to increase
profitability increase price.they can continue to increase price till the situation offset cost
push inflation.This is called profit push inflation.
• Higher tax-Government may enhance cost by introducing a variety of tax,rasing existing tax
particularly indirect tax. Example sales tax.the producer shift the burden to the consumer
through increase price.
• Availability of basic input –A price rise of general input causes a general increase in price
level and becomes a source of cost push inflation.
Effects of Inflation
• Effects on production
Creeping inflation is quiet desirable as it leads to expansion in production, employment,economic
activity, leading to more profit situation. After full employment is reached mild inflation takes the
form of hyper inflation.Firms find it beneficial to hoard things.
• Effect on Distribution
The producer manufacturer,traders big farmers they gain from inflation as prices of goods
increase more than cost of production.
• Farmers
Farmers gain as they gain during inflation.As debtors they had to give back less in real terms to
creditors.
• Debtors and creditors
Debtors are those who borrow money and repay it in future.Debtors gain as real money goes
down since they have to pay less to the creditors.
Control of inflation
Monetary measure
The central bank is the cheap functionary of monetary policy to check inflation ,it first checks the
volume of currency and avoid bank credit through quantitative and qualitative measures.
• Bank rate-the central bank increases the rate which will increase the market interest rate
thus inflationary rise in price is arrested by checking of excess demand.
• Open market operation-Through the sale of government security the money supply will be
reduced as the commercial bank has to give money to the central bank in exchange of
government security.
• Cash reserve Ratio-During inflation consumer credit facilities are curtailed by raising
down.Payment and reducing payment time in terms of selective basis.
• Fiscal measures
• Public expenditure-The government can reduce public expenditure .this will reduce money
from the market and hence demand for the goods.
• Taxation-increase in tax reduces the purchasing power in the hands of people direct tax like
income tax,wealth tax,expenditure tax,reduce disposable income reducing inflation.
• Inventory
• Fixed income group
• Entrepreneurs
• Government
Module 5 Banks
Commercial banks
It is a bank which deals with money and credit.A commercial bank accept deposit,make
business loans and offer related service.Commercial banks allow a variety of deposit accounts
such as checking,saving,and time deposit.These institution run to make a profit and own a
group of individuals.
Function of commercial bank
Primary Function
• Acceptance of deposit
• To advance loans
• Creation of credit
• Secondary Function
• Remmittance of fund
• Collection of payments
• Trusteship
• Purchasing and selling of security
• Representation and correspondence
• Safe custody of deposits
• Trade connection
• General utility function
• Supply ofstatistical and commercial information
• Supply of information regarding financial standing and credit worthiness of
businessman
• Sale and purchase of foreign exchange and issue of letter of credit or travellers cheque.
Central Bank
Function of central bank
• Bank of issue
• Banker and agent to the Government
• Bankers bank
• Custodian of Foreign exchange reserve
• Lender of last resort
• Bank of central clearance
• Agent of economic development
• Credit control
