What is Inflation?
Inflation is a very important term of economy as well as directly related to our day to day life. Whenever term Inflation strikes in our mind, image of increasing price of goods and services comes in our mind.
Inflation means continuous growth in price of goods and services over the period of time. Inflation means, “a sustain increase in the general price level of basket of selected goods and services in an economy over the period of time.” Inflation is calculated as annualised percentage change in a general price index.
Growth in general price level, decreases the purchasing power of currency. As we know, inflation has negative aspects in economy. When inflation rises, every rupee buys a smaller quantity of goods and services. The value of money decreases in the market and flow of money increases in the market.
But there are some positive aspects also. Inflation increases the demand due to money flow in market. Due to inflation, rate of unemployment decreases.
Except positive and negative aspects there are few mixed effect also. Due to inflation money flow in market increases, due to this demand increases that is good but increase in demand leads to decrease in supply.
What is Inflation target in India?
RBI Act, 1934, section 45ZA, defines the “Inflation Target”. Central Government in consultation with Central Bank of India determines the inflation target in terms of the Consumer Price Index, once in every five years.
After the determination of inflation rate, Central Government notifies the inflation target in the Official Gazette.
Inflationis controlled by RBI Monetary Policy tools. Function of RBI is to determine the targeted inflation rate for five year. On March 31, 2021,RBI determined 4 per cent Consumer Price Index (CPI) inflation as the target for the period from April 1, 2021 to March 31, 2026 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
Targeted consumer price index (CPI) inflation rate is= 4%
Upper tolerance limit of inflation is= Target inflation rate + 2% = (4% + 2%) =6%
Lower tolerance limit of inflation is= Target inflation rate – 2% = (4% – 2%) =2%
Targeted consumer price index (CPI) inflation rate period from = April 1, 2021
Targeted consumer price index (CPI) inflation rate period up to = March 31, 2026
RBI defines the sense of failure to achieve the inflation target:
(a) The average inflation is more than the upper tolerance level of the inflation target for any three consecutive quarters
OR
(b) The average inflation is less than the lower tolerance level of the inflation target for any three consecutive quarters.
Inflation has many effects such as:
- As inflation increases, every Rupee buys a smaller quantity of goods and service.
- The value of money decreases in the market and flow of money increases in the market.
- Purchasing power of people increases that is why demand increases but supply decreases.
- The rate of unemployment decreases in the market.
How inflation decreases purchasing power of currency?
As money flow in market increases, purchasing power of people increases. Due to increase in purchasing power of people, demand of goods and services increases. This increase in demand pushes prices a little higher.
Increase in demand leads, decrease in supply. This imbalance in demand and supply, pushes prices of goods and services a little higher.
Increase in price of goods and services, reduces the purchasing power of money. Every single rupee buys a smaller quantity of goods and services.
In short we can say that, as money flow in market increases, the value of money decreases.
With below example we can better understand the purchasing power of currency.
Mr. Parth visits a grocery store for purchasing some items. Mr. Parth purchases 1 packet of bread of rs. 40, one liter packed milk of rs 40, one fruit jam of rs. 15 and a chocolate of rs 5 for his son. Over the billing counter Mr. Parth pays total bills of Rs. 100 for all items he purchased.
After one year Mr. Parth again visits the same grocery store for purchasing the same items along with 100 rs only as per his past purchasing experience. Mr Parth picks up all items bread, milk, jam and chocolate.
This time over the billing counter Mr. Parth gets surprised because of bill worth of rs. 105. This time prices of all item were increased like bread of rs. 42, packed milk of rs. 42, fruit jam of rs. 16 and chocolate of rs. 5.
This time Mr. Parth could not purchase chocolate for his son cause of inflation. Inflation increased by 5%. Due to inflation, purchasing power of currency decreased. This time, in rs 100 Mr. Parth could not purchase all item. That shows decrease in purchasing power of currency.
What are the Stages of Inflation?
There are four stages of Inflation. These stages represents
- Creeping Inflation
- Trotting Inflation (Walking Inflation)
- Galloping Inflation
- Hyper Inflation
- Creeping Inflation: Creeping inflation is also known as mild inflation. Inflation rate which is increasing at slow pace but it is continue over the period of time is called creeping inflation. Creeping inflation has annual inflation rate in range of 0-3%, which is considered good for economy.
2. Trotting Inflation: Inflation rate which is increasing at moderate pace and it is continuous over the period of time is called trotting inflation. Trotting inflation has annual inflation rate in range of 3-10% in single digit. This inflation is very suitable for an economy. Inflation rate below 10% in single digit considered to be a moderate inflation
Inflation rate range from 3-6% is called walking inflation and it is considered the best inflation rate for the economy. Inflation at rate of 7-9% is an alarming signal for the government to control it before it turns into galloping inflation. Once inflation turns into double digit, it will be uncontrollable for the government.
3. Galloping Inflation: Inflation rate which increases at rapid pace in brief period of time is called galloping inflation. Inflation in double digit range 10-99% in a year is called galloping inflation.
Such form of inflation is dangerous for the economy as it mostly affects the middle and low-income classes of population. This inflation is uncontrollable for the government.
4. Hyperinflation: Inflation rate which increases at excessive or can say out of control pace in extremely short period of time is called hyperinflation. Hyperinflation is very high and typically accelerating inflation. Inflation in triple, four, five digit in a year OR double digit in a month is called hyperinflation.