What Do You Understand About ‘Inflation’ – Part 1

My nonagenarian mother, who has lost all sense of time, often asks me one question when I come home with a basket full of vegetables and groceries. Is the price of tomato Rs 2/- for 3 kgs? Is the price of rice Rs.15/- for a bag of 5 Kgs?  Well!! One might rightly conclude that she is living in a time warp. I would patiently explain to her that the world has moved ahead by leaps and bounds and ‘inflation’ has catapulted the price of tomato to Rs.60/- per kg today and rice to Rs.50/- a kg. She would be aghast and would sympathise with the ‘have-nots’ and in the same breadth give a few juiciest expletives to the people who run the country.

We often lament over the increase in price of the essential commodities and dismiss the government of the day as incompetent and also bring into the argument the august office of the Governor of the Central Bank of the country.

Is increase in prices of goods aka inflation something bad? Yes, to the uninitiated. Not always, to an economist.

So what is inflation?

• Is it increase in prices?
• Is it decrease in the value of money?
• Is it because more money chasing too few goods?
• Is it because the disposable income in the hands of people has increased?
• Is it the result of changing the methodology of measuring it?
• Is it the responsibility of the Government to tackle it?
• Is it the responsibility of the Central Bank to tame it?

Let us try to demystify the concepts in a way that a layman can get a hang of what it is.

Inflation is increase in the price you pay for goods and a consequent decrease in the value of money.

Inflation is consistent and sustained upward movement in prices measured by an index; wholesale price index, consumer price index…

A relentless and stubborn upward movement in prices, as measured by an index, let’s say Consumer Price Index over a period of time, and resulting in the concomitant decreasing purchasing power of the currency. It impacts adversely the fixed-wage earners, and is a disincentive to save.

What causes inflation?

Generally, modern economic theory describes the following:

• Cost-push inflation also known as the wage-price spiral is due to wage increases that force businesses to raise prices to cover higher labour costs, which in turn leads to demand for still higher wages
• Demand-pull inflation results from increasing consumer demand funded by easier availability of credit. In the recent years the global economy was witness to the easy money policy or quantitative easing pursued by some of the advanced economies which plunged the global economy to an unprecedented financial crisis.
• Monetary inflation caused by the expansion in money supply due to printing of more money by a government to cover its deficits.

To the above we may also add one or two causes that are prevalent in developing countries like India aka Emerging Market Economies (EMEs)…

More when we meet next…