Inflation

 What is Inflation?
 Related Terms
 Types of Inflation
 Measurement of Inflation
 Stages of Inflation
 Inflation Accounting
 Causes
 Effects
 Costs of Inflation
 Relation with GDP, Currency
 Measures to keep inflation in check
 Indian Economy & Inflation
 Conclusion

 Inflationis a sustained
increase in the general
level of prices of goods
and services in an
economy over a period
of time.

 decreasein purchasing
power of money.

1956 Commodities 2011
(Rupees (Rupees
Per Kg) Per Kg)
.30 Rice 32

.25 Wheat 35

3 Almonds 350

.20 Potato 16

Deflation Disflation

Reflation Stagflation

Related to basic economic
principles of supply and demand :

 Increase in the money supply.
 Increase in the aggregate demand
for goods and services.
 Commercial Policies
 Deficit Financing
 Banking policies
 Increasing costs of production
 Anti – social activities

On rising
prices

On
causes

Creeping inflation

Walking Inflation

Running Inflation

Galloping Inflation

Hyper inflation

Demand Pull Inflation Cost Push Inflation

 Increase in aggregate  Cost push inflation
Demand succeeds Demand-pull
inflation
 More money chases
relatively less quantity  Demand for factors of
of goods and services Production increases

 excess of demand  Prices are “pushed up”
pushes up the prices of by increase in costs of
goods and services factors of production

Goods that are
representative of the
economy are put together

market
basket

 Adopted by countries such as India,
Philippines etc
 Uses 435 commodities for inflation
calculation which represent various strata of
the economy
 It is calculated on a base year and In India
base year is 2004-05
 WPI = Base yr price (Rs 100) + rate of
increase in price from base yr till the yr
under consideration

 Weighted average of 435 commodities to
arrive at overall WPI
 Weights depend on the commodities
influence on economy
 (WPI of end of year – WPI of beginning of
year)/WPI of beginning of year x 100
 For example, WPI on Jan 1st 2010 is 106 and
WPI of Jan 1st 2011 is 109 then inflation rate
for the year 2010 is
 (109 – 106)/106 x 100 = 3.42%

 Adopted by countries such as USA, UK, Japan and
China.

 commodities for inflation calculation are the
goods and services purchased by a “typical
consumer”

 For instance, in January 2007, the U.S. Consumer
Price Index was 202.4, and in January 2008 it was
211

 (211.08-202.41)/202.41*100 = 4.28%

 Index prices are expressed in relation to the
base year price

 Modifying the weights assigned to the goods

 New products may be introduced, older products
disappear but both the sorts of goods are
included in the "basket“

 Inflation numbers are often seasonally adjusted

 May focus only on certain kinds of prices,
or special indices

Pre-full
employment stage

Full employment
stage

Post-full
employment stage

 Adjusting the financial statements as per the
changes in the purchasing power of money.

 Two ways of restatement/adjustment

 Accounting for Current purchasing power of
rupee
 Current cost accounting

 Wholesale price index of RBI is used
 Distinction between Monetary and Non-Monetary
items
 Only Non-Monetary items need to be restated
 Ex : Investments were made at a cost of Rs 6L in
July 2005 and price index was 300.
On 31st Mar 2011 price index is 320 and market
value of investment is 6,10,000/-
 Loss = Cost – Market value
6L*320 = 6.4L 6.1L
300
 Loss= 30,000/-

 Takes into account the price changes
relevant to the particular firm/Industry and
not economy as a whole
 Important features
 Fixed assets are shown at their current value
 Stocks are shown at the value of their
business
 Depreciation is calculated on current values
 Difference between current values and
depreciated costs of FA is transferred to
revaluation reserve a/c

 Depreciation adjustment
Particulars Historical Cost Current Cost
Accounting Accounting
Value of the asset 50,000 1,00,000
Current depreciation 5,000 10,000
Accumulated dep (Op bal) 15,000 30,000
Total accumulated dep 20,000 40,000
Balance sheet value (WDV) 30,000 60,000
 Backlog depreciation
= 1,00,000-60,000-(15,000+10,000) = 15,000
Should be charged to revaluation reserve

Effects on production Distributional effects Other effects

Misallocation of Debtors and
resources Government
creditors

Reduction in Business Balance of
saving community payments

Hinders foreign Fixed Income
capital groups Exchange rate

Investors Social

Farmers

 Business Growth

 Plunging Debt Values

 Stock Values Increases

 Asset Values Increases

 International competitiveness

 Confusion and Uncertainty

 Shoe leather costs

 Income redistribution

 Boom and Bust Economic Cycles

 Cost of Reducing Inflation

 Fiscal Drag

 People spend more and GDP increases

 “The Slippery Slope”

 Too much of GDP growth is dangerous as it leads
to increase in inflation

 If GDP was calculated to be 6% higher than the
previous year, but inflation was measured 2%
then the GDP rate to be reported is 4%

 GDP figures are reported after adjusting for
inflation.

Relationship between inflation and interest
rates for a particular currency decide whether
or not that currency is growing stronger or
weaker

Buying power Increase the
Increase in money Prices will
of money is bank interest
supply increase
eroded rates

 Zimbabwe’s inflation was
1,00,000% in 2008 and was
recorded as highest in the
world !!!

1USD = 25 million Zimbabwean dollar

 Issued a 100 trillion Zimbabwe dollar note

 Excess Supply of Money which is not supported by
growth of Output of Goods and Services

 It is neither high nor steady

 Despite high inflation and colossal corruption
patterns - India overcame the reparation done by
global recession with little slower growth rate

 The latest data of the government food price index
shows they jumped almost 17% last financial year

 Inflation, interest rates, fiscal deficit, current
account deficit and depreciation of local currency
could be the reason for slowing down the economic
growth

Inflation Rate
14
12
12 10.9
10 8.4 8.5
7.65
8
5.8 6.4
6
3.8 3.8 4.2
4 Inflation Rate
2
0

 Combined Consumer Price Inflation stood at an
annual 7.65%

 This was the first time Consumer Price Inflation
Data released by CSO

 Government had been relying on WPI data which
economists say, does not capture the inflation
situation fully

 Globally, Central Banks and Policy Makers rely on
CPI Data

 Oils, milk and milk products, Fruits, Clothing, fuel
continued to remain stubborn.

 Vegetables Prices declined an annual 24.87%

 Economists said its difficult to draw any conclusion
from the CPI data – lacks history

 RBI has raised interest rates 13 times since march
2010 to tame price pressures

 CPI data showed that inflation continues to remain
firm

Monetary Fiscal Measures Other Measures
Policies • Reduction in • Increase in
• Issue of New Public Expenditure Production
Currency • Increase in Taxes • Proper commercial
• Cash Reserve Ratio • Increase in policy
• Bank Rate of Imports • Encouragement to
Interest • Decrease in saving
Exports

You now know that inflation isn't basically good
or bad.

 When inflation goes up, there is a decline in the
purchasing power of money.

 Variations on inflation include deflation and
stagflation.

 Two theories as to the cause of inflation are
demand-pull inflation and cost-push inflation.

 Lack of inflation is not necessarily a good thing.

 Inflation is a serious problem for fixed income
investors.

Inflation

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