Money is “anything” that is generally acceptable as a means of exchange and which at the same time acts as a measure and store of value. “Anything” – implies a thing to be used as money which need not be necessarily composed of any precious metal. The only necessary condition is that, it should be universally accepted by people as a medium of exchange which is guaranteed by the Government of the country.
FUNCTION OF MONEY
Money performs five important functions
1. Medium of exchange
• For transaction in any economy, money is used in the form or currency or checks as a medium of exchange. The use of money as a medium of exchange promotes economic efficiency by minimizing the time spent in exchanging goods and services (barter system).
2. Measure of value/Unit of Account
• Money is used to measure units in economy. We measure the value of goods and services in terms of money, just as we measure weight in terms of kilos or distance in terms of meters.
3. Store of value
• Money functions as a repository of purchasing power over time. This function of money is useful, because most of us do not want to spend our income immediately upon receiving it, but rather prefer to wait until we have the time or the desire to shop.
4. Standard or Deferred Payment
• Money facilitates not only the current transactions of goods and services but also their credit transactions. It facilitates credit transactions when present goods are exchanged against future payments. In the modem world, the bulk of deferred payments are stipulated in money terms only.
5. Transfer of value
• It involves the transferring of value of any asset to another or to any institution or to any place by transferring money. This transfer can take place irrespective of places, time and circumstances. Transfer of purchasing power, which is necessary in commerce and other transaction, has become available because of money.
CLASSIFICATION OF MONEY
Actual Money – Money which actually circulates in the economy in terms of which all payments are made and general purchasing power is held as a medium of exchange. In Pakistan, notes and coins of all denominations are actual money.
Money of Account – In terms of which prices are expressed and accounts are maintained. Normally, actual money and money of account are the same but sometimes they are different. For example: Paisa is a money of account in Pakistan but it is not actual money. Now a day, it is no more in circulation.
Metallic Money – It’s made of metal such as gold and silver. Coins of all denomination circulating in economy are examples of metallic money. Metallic money is classified into two categories:
• Full bodied money: If the face value of money is equal to its value as a commodity, it is called full bodied money. If a gold coin of face value Rs. 100/- contains gold worth of Rs. 100/- it will be called full bodied money or sometimes standard money
• Token Money: If the face value of money is more than its value as commodity or intrinsic value it is known as token money.
Paper Money – Money made of paper is called paper money. It includes different denomination. Paper money is further classified into following forms.
• Representative Paper Money: If paper is issued by keeping hundred percent gold reserve of full bodied coins or gold bullion, it will be called representative money.
• Convertible Paper Money: If paper money can be converted into gold coins or gold bullion on demand it is referred to as convertible money. This type of money is issued by keeping metallic reserve of equal amount behind it.
• Fiat or In-convertible Paper Money: which cannot be converted into full bodied coins or gold bullion on demand. It is usually issued without keeping metallic reserve behind it.
Legal Tender Money – Money which has a legal approval behind it and people are bound by law to accept it in all payments. Nobody can refuse to accept it. Legal Tender Money can be classified into:
• Limited Legal Tender: which can be given in payments only upto a certain limit. The payee can refuse to accept it beyond that limit. In many Asians countries 25 paisa coin and coins of low denominations are limited legal tender. These coins can be given as payments up to 50 rupees only.
• Unlimited Legal Tender: Unlimited legal tender means that money which can be given in payments up to any limit.
Optional Money – That form of money which is used as a medium of exchange but it has no legal force behind it. It includes credit instruments like cheques, bills or exchange and CDRs etc. which are generally acceptable in payments.
Hot Money- Money that moves regularly and quickly between financial markets so that investors could ensure they are getting the highest short-term interest rates available. Hot money continuously shifts from countries with low interest rates to those with higher interest rates affecting the exchange rate (if there is a high sum) and also has the potentiality to impact a country’s balance of payments.
Commodity Money – Its value is derived from the commodity out of which it is made. The commodity itself represents money, and the money is the commodity. For instance, commodities that have been used as a medium of exchange include gold, silver, copper, salt, peppercorns, rice, large stones etc.
Commercial Bank Money – These are the demand deposits which are claims against financial institutions which can be used for purchasing goods and services.
POSITION OF INDIAN RUPEE
The Indian Rupee is a mixture of the standard money and the token money. Like standard money, it is unlimited legal tender, and like the token money, its face value is greater than is intrinsic value. The Indian rupee is said to be a note printed on silver (now Nickel).
MONEY SUPPLY IN INDIA
• It refers to total supply of money in circulation in a given country’s economy at a given time. Money supply is considered as an important instrument for controlling inflation by some of the economists.
• Economists analyze the money supply and develop policies revolving around it through controlling interest rates and increasing or decreasing the amount of money flowing in the economy.
• Money supply data is collected, recorded and published periodically by the RBI. These are also known as Reserve Money.
• (M0) = Currency in circulation + Bankers’ deposits with the RBI + Other deposits with the RBI = Net RBI Credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks + RBI’s net is foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities.
• In other words, it is the most liquid measure of the money supply. It only includes cash or assets that could quickly be converted into currency. This measure is known as narrow money because it is the smallest measure of the money supply.
• M1 (also called as the Narrow Money) = Currency with public (coins, currency notes etc.) + demand deposits of the public.
• In other words, Narrow money is a category of money supply that includes all physical money like coins and currency along with demand deposits and other liquid assets held by the central bank.
• M2 = M1 +Post office saving deposits.
• M3 (also called as the Broad Money or Money aggregates) = M1 + Time deposits of public with the banks.
• M4 = M3 + Total Post office deposits (includes fixed deposits with the post offices)
Monetary multiplier represents the maximum extent to which the money supply is affected by any change in the amount of deposits. It equals ratio of increase or decrease in money supply to the corresponding increase and decrease in deposits.
• Required Reserve Ratio is the fraction of deposits which a bank is required to hold in hand. It can lend out an amount equals to excess reserves which equals 1 – required reserves.
• Higher the required reserve ratio, lesser the excess reserves, lesser the banks can lend as loans, and lower the money multiplier.
• Lower the required reserve ratio, higher the excess reserves, more the banks can lend, and higher is the money multiplier.
• In the above relationship it is assumed that there is no currency drainage, i.e. the borrowers keep 100% of the amount received in banks.
• It describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price.
• Liquidity might be our emergency savings account or the cash lying with us that we can access in case of any unforeseen happening or any financial setback. Liquidity also plays an important role as it allows us to seize opportunities.
• Market Liquidity refers to the extent to which a market, such as a country’s stock market or a city’s real estate market, allows assets to be bought and sold at stable prices. Cash is the most liquid asset, while real estate, fine art and collections are all relatively illiquid.
The importance of Liquidity
• An investor may need both liquid and illiquid assets. We need liquid assets to deal with any unexpected short-term crisis. But illiquid assets may offer greater chance for capital gains and higher yield.
• A liquidity ratio refers to the amount of liquid assets to overall assets. If a firm is highly liquid – it has a high proportion of assets that can easily be converted to cash to pay off any obligations.
Cash reserve ratio
• A bank may be required to keep a certain percentage of its assets in the form of liquid assets. It is the fraction of customer deposits held in cash reserves.
• Cash reserves are not profitable. If a bank lends deposits to other customers, it can charge interest and make more profit. But bank loans are highly illiquid because the bank cannot immediately ask for the loan back.
FLOW OF MONEY
• A technical indicator calculated by multiplying a change in share price by the number of shares traded. Money flow is positive when a stock rises and negative when it declines. The indicator is used to investigate the momentum behind a price trend.
The importance of Money Flow:
• Money Flow is an important indicator of volume, a way to represent the inflow and outflow of investor’s money for security.
• Positive money flow means that investor interest is increasing, raising the demand for a security and, ostensibly, its price. Negative money flow shows the opposite: Investors are either capturing gains or losing faith in the value of the security or index, likely leading to declining prices.
• A common strategy stock traders implement with the money flow indicator is to enter or exit trades according to the overbought or oversold readings provided by the indicator.
DIGITIZATION OF MONEY
• The advent of the web and digitization has changed the way we work, shop, bunk, travel, educate, govern, manage our health and enjoy life by automatizing it.
• The technologies of digitization enable the conversion of traditional forms of information storage such as paper and photographs into the binary code (ones and zeros) of computer storage.
• A sub-set is the process of converting analog signals into digital signals. But much larger than the translation of any type of media into bits and bytes is the digital transformation of economic transactions and human interactions.
• With the passing of time the need has been felt in the banking sector and various other transactions due to increase in the volume and amount of banking transaction and rapidly increasing customers.
• To increase the cost of the product and generate more revenue it was realized that digitization and automation is need of the time especially for Banking Sector.
• Now, some of the banks are moving towards automated cash receipt/payment through recyclers, account opening through online with Aadhar validation, cheque sorting and processing for clearing and so many.
Plastic money is a term that is used predominantly in reference to the hard plastic cards we use every day in place of actual bank notes. They can come in many different forms such as cash cards, credit cards, debit cards, pre-paid cash cards and store cards.
5 different kinds of plastic money
A. Credit card
1. Cashless payment with a set spending limit
2. Payment takes place after the purchase
3. Great flexibility because of installment facility
4. Most well-known credit cards: American Express, MasterCard, Visa
B. Charge cards
1. Cashless payment without a set spending limit
2. Payment takes place after the purchase
3. No credit or installment facility
4. Most well-known charge cards: American Express, Diners Club
C. Debit card
1. Card is directly linked to the cardholder’s bank account
2. Transaction is debited immediately from bank account
3. No credit or installment facility
4. Most well-known debit cards: Maestro, Postcard
D. Customer card/store card (PLCC)
1. Card with payment and credit function
2. Can only be used at specific retailers
3. Well-known customer cards: myOne, Globus, Media Markt etc.
E. Prepaid card/gift card
1. Card is topped up with credit before use
2. No credit or installment facility
3. Open system (American Express, Visa, MasterCard) or closed system (can only be used at specific retailers)
The recent demonetization by the Government of India targeted towards killing three birds with one stone – black money, political opponents and subtly hard cash transaction.
LESS CASH ECONOMY: VISION 2018
• Reserve Bank of India (RBI) on June 2016, unveiled ‘Payment and Settlement System in India: Vision – 2018’ aimed at building best of class payment and settlement system for a ‘Less Cash’ India.
• Vision 2018 revolves around 5Cs: Coverage, Convenience, Confidence, Convergence and Cost.
• To achieve these, Vision 2018 will focus on four strategic initiatives such as responsive regulation, robust infrastructure, effective supervision and customer centricity.
• The regulatory framework, based on consultative approach, aims at achieving enhanced coverage of the payment systems coupled with convenience for end-users.
• A key objective would be to ensure a robust payments infrastructure in the country to increase accessibility, availability, interoperability and security.
• The oversight and supervisory framework would focus on strengthening the resilience of both large value and retail payment systems in the country.
• With increasing use of technology-based innovative payment products, the strategic initiatives under Vision-2018 are expected to reduce paper-based instruments significantly and lead to accelerated growth in mobile banking and other modes of electronic payments.
• To promote mobile phones as access channel to payment and banking services, the guidelines will be reviewed to address issues related to customer registration for mobile banking, safety and security of transactions, risk mitigation and customer grievance redressal measures.
• The White Label ATM Guidelines will accordingly be examined holistically and targets realigned to meet present conditions as the same has not resulted in the much needed growth in ATM infrastructure in the desired geographical segments of the country i.e. Rural and Semi-Urban areas.
Cashless Economy: From Barter System to Cash System and then Less Cash Economy
• A cashless economy is one in which all the transaction are done using cards or digital means. The circulation of physical currency is minimal.
• Money in liquid form (in hand cash) guaranteed by the Central Bank and backed by the Government of India is a promise made to citizen to complete the transactions by using various denominations.
• By drawing out liquidity from the market RBI promotes the use of plastic money in the form of cash cards, credit cards, debit cards, pre-paid cash cards and store cards etc.
• India uses too much cash for transactions. The ratio of cash to gross domestic product is one of the highest in the world – 12.42% in 2014 compared with 9.47% in China or 4% in Brazil.
• Less than 5% of all payments happen electronically in India which is very less.
Steps taken by RBI and Government to discourage use of cash:
• Promotion of Mobile Wallet which will allow users to send/receive money, pay bills, recharge mobiles, book movie tickets, send physical and e-gifts both online and offline.
• No new license will be given to payment banks.
• India is liberalizing the FDI norms in order to promote E-commerce.
• Government has also launched Unified Payment Interface (UPI) in order to make electronic transfer much faster and simpler.
Inflation refers to gradual rise in the general price level in the economy and a fall in purchasing power of money over a period of time. In simple words, inflation is nothing but a rise in average price level of all the goods and services in an economy. Inflation occurs when too much money chases a few goods, that is, even though money supply increases the supply of goods and services does not increase commensurately.
Types of Inflation
On the basis of rate of Inflation, it is categorized into four types
• Creeping Inflation: When the rise in prices is very slow (less than 3% Per annum) like that of snail or creeper. Such inflation is safe and necessary for economic growth.
• Walking or Trotting Inflation: When prices rise moderately and the annual inflation rate is of a single digit (3 – 10%). Such inflation is a warning signal for the government to control it before it turns into running inflation.
• Running Inflation: When prices rise rapidly like the running of a horse at a rate of speed of 10 – 20% per annum. Such inflation requires strong monetary and fiscal measures to control otherwise will lead to Hyper-inflation.
• Galloping or Hyper-Inflation: When price rise is in between 20 – 100% per annum or even more. Such inflation brings total collapse of the monetary system because of the continuous fall in the purchasing power of money.
On the basis of Cause-Based Inflation it is of Five Types
• Demand Pull Inflation: When aggregate demand is rising while the available supply of goods is less. This kind of inflation can be described by ‘too much money chasing a few goods’. One of the reasons for demand pull inflation can be the increase in money supply.
• Cost Push Inflation: Also referred to as supply shock inflation occurs due to reduced supplies due to increased prices of inputs. For example, an increase in price of international crude oil adversely affects the inputs of almost all the items in a country like India, which neither has alternatives to oil for energy needs nor has significant amount of domestic oil production.
• Comprehensive and Sporadic Inflation: When the prices of all the commodities rises its known as Comprehensive Inflation. It is also referred as Bottleneck Inflation. On the other hand, Sporadic Inflation is a sectoral inflation in which the prices of a few commodities rise because of certain physical bottlenecks which may impede any attempt to increase their production.
• Open and Suppressed Inflation: It is said to be open when the Government takes no steps to control the rise in the price level. It is caused due to uninterrupted operation of the market mechanism. On the other hand, Suppressed Inflation when the Government actively intervenes to check the rise in the price level.
• Mark-up Inflation: It causes due to the peculiar method of pricing adopted by the big business organisations. When the big business organizations calculate their production costs first and then add to these costs a certain mark-up to yield the targeted rate of profit.
What causes Inflation?
Inflation can arise from internal as well as external events
• Some inflationary pressures direct from the domestic economy, for example the decisions of utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies of the food retailers based on the strength of demand and competitive pressure in their markets. A rise in the rate of VAT would also be a cause of increased domestic inflation in the short term because it increases a firm’s production costs.
• Inflation can also come from external sources, for example a sustained rise in the price of crude oil or other imported commodities, foodstuffs and beverages. Fluctuations in the exchange rate can also affect inflation – for example a fall in the value of the Rupees against other currencies might cause higher import prices for items such as foodstuffs from Western Europe or technology supplies from the United States – which feeds through directly or indirectly into the consumer price index.
Due to Demand Pull Factors Inflation can occur such as
• Increase in Government Expenditure: this increase results in increased demand for goods and services and consequent increase in prices. This is because increased government expenditure results in putting large money in the hands of public, thereby putting to affect too much money chasing too few goods.
• Rising Population: It acts as an important factor in pushing up prices because of increased demand especially when the supply is unable to meet the demand.
• Black Money: A large part of the black money is used in buying and selling of real estate in urban areas, extensive hoarding and black marketing in essential wage goods, such as cereals, pulses, etc. Black money, therefore, fuels demands and leads to rise in prices.
• Changing Consumption Patterns: Increase income bring more demands for food items that people eat more frequently. For example: Increased consumption of protein rich foods such as pulses, eggs, fish and poultry were apparently driving up their prices in the economy.
Due to Cost Push Factors Inflation can occur such as
• Rise in wages: At times rise in wages, if greater than rise in productivity, increases the costs therefore increasing the prices too.
• Tax increase: Increase in indirect taxes also leads to cost side inflation. Taxes such as custom and excise duty raise the cost of production as these taxes are levied on commodities.
• Increase in administered prices: such as the MSP (Minimum Support Price) for the food grains, petroleum products etc. also leads to inflation as they have a huge share in budget of common citizens.
• Infrastructural bottlenecks: Infrastructural bottlenecks such as the lack of proper roads, electricity, water etc. raises per unit cost of production. This is one of the prime reasons for inflation in the context of Indian economy.
• Fluctuation due to seasonal and cyclical reasons: Owing to events such as failed monsoons there is a drop in agricultural productivity, which inevitably results in inflation at times.
• There are several ways to measure inflation among which India uses Wholesale Price Index and Consumer Price Index.
• Based on the Population Coverage the inflation indices are developed to understand the levels of inflation for certain sets of population such as Consumer Price Index (CPI), Producer Price Index (PPI), and Wholesale Price Index (WPI) etc.
• On the basis of items, the inflation indices are developed to understand the levels of inflation for certain sets/basket of items.
• One feature common to all the price indices is the use of ‘Base Year’ which is a particular year used as a reference to calculate the price rise in a particular year. For Example: 2012 is the base year for CPI and 2004-05 for WPI.
• In India, Consumer Price Index (CPI) and Wholesale Price Index (WPI) are two major indices for measuring inflation in comparison to USA where CPI and PPI (Producer Price Index) are used to measure inflation.
• The Wholesale Price Index (WPI) was main index for measurement of inflation in India till April 2014 when RBI adopted new Consumer Price Index (CPI) (combined) as the key measure of inflation.
A. Wholesale Price Index: (Headline Inflation)
• Calculated and released on weekly basis for primary article and Fuel Group, by the Office of the Economic Adviser in Ministry of Commerce and Industry, Government of India. However, this has been discontinued since 2012 and now it is released on monthly basis.
• The new WPI index is based on the recommendation of a working group set up under the guidance of Abhijit Sen.
• WPI is an important statistical indicator, as various policy decisions of the Government like inflation management, monitoring of prices of essential commodities etc. are based on it.
• Due to two base year for WPI (2004-05) and CPI (2012), the difference in rate occurs for WPI and CPI.
• There are total 676 items in WPI and inflation is computed taking 5482 Price Quotations. These items are divided into three broad categories:
• Primary Articles
• Fuel and Power
• Manufactured Products
• One of the major limitations of WPI is that it does not include services such as the health, IT, Education, transport etc. Also it does not account for the products of the unorganized sector in India, which constitutes about 35% of the manufactured output of the Indian economy.
• We note here that WPI does not take into consideration the retail prices or prices of the services.
B. Consumer Price Index
• India also measures inflation at the consumer level by the means of CPI. It is the measure of change in retail prices of goods and services consumed by defined population group in a given area with reference to a base year.
• Due to wide disparities in consumption basket for different segment of consumers, India has not been able to evolve a single and comprehensive consumer price index. The four CPIs adopted by India are:
1. Consumer Price Index for Industrial Workers (CPI-IW)
• Compiled by Labour Bureau, an attached office under Ministry of Labour & Employment. It measures a change over time in prices of a fixed basket of goods and services consumed by Industrial Workers.
• The target group is an average working class family belonging to any of the seven sectors of the economy- factories, mines, plantation, motor transport, port, railways and electricity generation and distribution.
• CPI (IW) is currently calculated at base 2001=100 for 78 centers and prices are collected from 289 markets across these 78 centers.
• It contains 120–160 commodities in its basket. Basically, this index specifies the government employees (other than banks’ and embassies’ personnel).
• The index has a time lag of one month and is released on the last working day of the month. It is used for wage indexation and fixation of dearness allowance for government employees which is announced twice a year.
• When the Pay Commissions recommend pay revisions, the base is the CPI (IW).
2. Consumer Price Index for Urban Non Manual Employees: (CPI-UNME):
• Having 1984-85 as the base year and 146-365 commodities in the basket for which data is collected monthly with two weeks’ time lag.
• This price index has limited use which is basically used for determining dearness allowances (DAs) of employees and some foreign companies operating in India (i.e. Airlines, Communications, Banking, Insurance, embassies’, and other financial services).
3. Consumer Price Index for Agricultural Labours): (CPI AL)
• Having 1986-87 as its base year with 260 commodities in its basket. The Data is collected in 600 villages with a monthly frequency and has three weeks time lag.
• The Index is used for revising minimum wages for agricultural labourers in different states.
4. Consumer Price Index for Rural Labourers/workers: (CPI RL):
• Having 1983 as the base year with 260 commodities in its basket for which data is collected from 600 villages on monthly frequency with three weeks time lag.
• In 2011, the CSO brought a revised CPI, having CPI (Urban), CPI (Rural) and CPI (Urban + Rural) with 2010 as the base price. The combined one would take into account the data from both the indices taking appropriate weights.
• CPI has much larger weightage in comparison to WPI in primary articles which is 57%.
C. Producer Price Indexes (PPI):
• These are indices that measure the average change over time in selling prices by producers of goods and services. They measure price change from the point of view of the seller.
• Majority of OECD countries measure inflation based on Producer Price Index (PPI) while only some uses WPI. Countries like Japan, Greece, Norway and Turkey use WPI.
D. Services Price Index (SPI):
• The contribution of the tertiary sector in India’s GDP has been strengthening for the past 6 to 7 years and today it stands approximately at 54 per cent. The need for a service price index (SPI) in India is warranted by the growing dominance of the sector in the economy. There is no index, so far, to measure the price changes in the service sector.
• The present inflation (at the WPI) only shows the price movements of the commodity-producing sector i.e. it includes only the primary and the secondary sectors-the tertiary sector is not represented by it.
• At present, efforts are being made to develop service price indices for selected services initially on an experimental basis (covering road transport, railways, airways, business, trade, port, postal telecommunications, banking and insurance services only).
• The concept is used to estimate the inflation by excluding food and energy prices form the basket of goods and services that represents a typical households’ consumption. Such a measure does not include the volatile items, which may distort the true picture of inflation in the economy.
• In mid 2012, RBI Governor threw up the conundrum posed by this “Core” inflation by saying “In our economy, where food constitutes nearly 50% of consumption basket and fuel has a weight of 15%, can a measure of inflation that excludes them can be called “Core”.
EFFECTS OF INFLATION
• As we know Inflation is the increase in the price of general goods and service. Thus, food, commodities and other services become expensive for consumption. Inflation can cause both short-term and long-term damages to the economy; most importantly it causes slow down in the economy.
• People start consuming or buying less of these goods and services as their income is limited. This leads to slowdown not only in consumption but also production. This is because manufactures will produce fewer goods due to high costs and anticipated lower demand.
• Banks will increase interest rates as inflation increases otherwise real interest rate will be negative. (Real interest = Nominal interest rate – inflation). This makes borrowing costly for both consumers and corporate. Thus people will buy fewer automobiles, houses and other goods. Industries will not borrow money from banks to invest in capacity expansion because borrowing rates are high.
• Higher interest rates lead to slowdown in the economy. This leads to increase in unemployment because companies start focusing on cost cutting and reduces hiring. Remember Jet Airways lay off over 1000 employees to save cost.
• Rising inflation can prompt trade unions to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation.
• Inflation affects the productivity of companies. They add inefficiencies in the market, and make it difficult for companies to budget or plan long-term. Inflation can act as a drag on productivity as companies are forced to shift resources away from products and services in order to focus on profit and losses from currency inflation.
DEMONETIZATION AND IMPACT ON INFLATION
• The Demonetization has impacted the inflation negatively. Consumer spending activity fell to a near halt. Consumers are refraining from making any purchases except essential items from the consumer staples, healthcare, and energy segments.
• The real estate sector, which includes a lot of cash and undocumented transactions, slowed down significantly as well as Metropolitan and Tier 1 cities reported a fall in house prices up to a 30%.
• Food item inflation, measured by changes in the Consumer Food Price Index, accounts for 47.3% of the overall CPI. Due to 86.4% of the value of the currency notes in circulation going out of the financial system and re-monetization being slow, the supply and demand of food items fell. It will exert more downward pressure on inflation.
OTHER RELEVANT TERMS RELATED TO INFLATION
• It is a contraction in the supply of circulated money within an economy, and therefore the opposite of inflation.
• A reduction in money supply or credit availability is the reason for deflation in most cases. Reduced investment spending by government or individuals may also lead to this situation. Deflation leads to a problem of increased unemployment due to slack in demand.
• Deflation is different from disinflation as the latter implies decrease in the level of inflation whereas on the other hand deflation implies negative inflation.
• It is a situation which is characterized by negative growth rate of GDP into successive quarters. Some of the indicators of a recession include slowdown in the economy, fall in investments, fall in the output of the economy etc.
• It is an extreme form of recession and characterizes a situation in which the recession may have gone on for too long resulting in depression of the economy.
• A common rule of thumb for recession is two quarters of negative GDP growth. The corresponding rule of thumb for a depression is a 10 percent decline in gross domestic product (GDP).
• An inflationary situation in an economy, which results out of a process of wage and price interaction ‘when wages press prices up and prices pull wages up’, is known as the inflationary spiral. It is also known as the wage-price spiral.
• This wage-price interaction was seen as a plausible cause of inflation in the year 1935 in the US economy, for the first time.
• It is a situation often deliberately brought by the government to reduce unemployment and increase demand by going for higher levels of economic growth.
• Governments go for higher public expenditures, tax cuts, interest rate cuts, etc. Fiscal deficit rises, extra money is generally printed at higher level of growth, wages increase and there is almost no improvement in unemployment.
• Re-flation can also be understood from a different angle-when the economy is crossing a cycle of recession (low inflation, high unemployment, low demand, etc.) and government takes some economic policy decisions to revive the economy from recession, certain goods see sudden and temporary increase in their prices, such price rise is also known as re-flation.
• It is a condition of slow economic growth and relatively high unemployment (economic stagnation) accompanied by rising prices, or inflation and decline in GDP. It’s an economic problem defined in equal parts by its rarity and by the lack of consensus among academics on how exactly it comes to pass.
• Usually, when unemployment is high, spending declines, as do prices of goods. Stagflation occur when the prices of goods rise while unemployment increases and spending declines.
• Stagflation can prove to be a particularly tough problem for governments to deal with due to the fact that most policies designed to lower inflation tend to make it tougher for the unemployed, and policies designed to ease unemployment raise inflation.
• It brings sustained price rise in some particular commodities only while at the same time other commodities can show deflation (lowering price).
• For Example: In the beginning of year 2010-11 India had inflation in certain food commodities such as food grains, pulses, and sugar. Later in the year prices of these commodities stabilized but there was price spike in commodities such as onions, milk etc. that is a condition of skewflation prevailed at that time.
• It refers to the tendency of a small change from a low initial amount to the current amount which is translated into a large percentage and appears as large.
• In other words, Inflation is calculated from a base year in which a price index is assigned the number 100. For example, if the price index in 2010 was 100 and the price index in 2011 rose to 110, the inflation rate would be 10%. If the price index rose to 115 in 2012, what would be the best way to assess inflation?
• On the one hand, prices have only risen 5% over the previous year, but they’ve risen 15% since 2010. The high inflation rate in 2011 makes the inflation rate in 2012 look relatively small and doesn’t really provide an accurate picture of the level of price increases consumers are experiencing. This distortion is the base effect.