Hi there! Hope the previous two blog articles have introduced you to the concept of inflation.
We all live in an inter-connected world. What happens in Timbuktu, impacts people living in Tamil Nadu. This inter-connectedness between economies creates what we term as externalities and in the last blog a reference was made to the impact of the American president sneezing and the price of ladies’ finger going up in Aminjikarai. Let us try and understand this.
We know very well that when money pours in to a place, the price shoots up. So, when too much money chases paper or real assets, the price of the assets also shoot up, but in different forms. Advanced economies follow what is called Quantitative Easing (QE) in the pursuit of their monetary policy. Please visit the link below to learn about Quantitative Easing.
In layman’s terms, quantitative easing means the central bank of the country printing more money and pumping it into the economy to boost spending and induce growth. Further, Interest rates in the advanced economies have been abysmally low while in the emerging economies it is attractively high. Money, therefore, flows into economies that offer better returns.
The excess money, generated in the advanced economies in the wake of Quantitative Easing, finds its way to the emerging economies either as Foreign Institutional Investment and / or debt or as other capital flows to fund the growth engines of the economy. Such flows increase the supply of money in the recipient economies and if not managed properly, the excess money in circulation has a tendency to push the price levels. Economists refer this as monetary inflation.
So, inflation could result from a combination of all the reasons namely cost-push, demand-pull, monetary growth.
Let us turn our attention to some of the other jargons that are used with inflation.
Inflation rate or rate of Inflation – The inflation rate is generally measured on a percentage basis in annual terms. In other words, the percentage increase of prices over the previous year. So if something cost Rs10.00 a year ago and costs Rs11.00 now there has been 10% inflation. Inflation is measured in an index form, either as “consumer price index” or “whole sale price index” and the percentage change in this index from one year to the next is commonly called as the inflation rate. This is a misunderstood term. When Government or RBI says that the inflation rate is coming down, sometimes people reading this statement think that the price is coming down. But what it means is that the price is still increasing but not as fast as in the previous comparable period. Which means, the inflation or price is rising at a decreasing rate. Different types of inflation are those which have varying inflation rate. When the price rises around 3% it is called creeping inflation. When it raises around 3-105 it is called pernicious inflation. When it raises above 10% it is called galloping inflation. But the worst is hyperinflation. That’s when prices rise more than 50% a month. This occurs mostly due to war time or military spending without commensurate production of goods and services. Fortunately for us, it is very rare.
The quantitative easing, we discussed above can lead to asset inflation. It can be gold, oil and natural gas, or paper asset like equity.
We will demystify QE in the subsequent blogs… chao…