Causes and Effects of Inflation

By inflation one generally means rise in prices. To be more correct inflation is persistent rise in the general price level rather than a once-for-all rise in it, while deflation is persistent falling price. A situation is described as inflationary when either the prices or the supply of money are rising, but in practice both will rise together. These days economies of all countries whether underdeveloped, developing as well developed suffers from inflation. Inflation or persistent rising prices are major problem today in world. Because of many reasons, first, the rate of inflation these years are much high than experienced earlier periods. Second, Inflation in these years coexists with high rate of unemployment, which is a new phenomenon and made it difficult to control inflation.

An inflationary situation is where there is ‘too much money chasing too few goods’. As products/services are scarce in relation to the money available in the hands of buyers, prices of the products/services rise to adjust for the larger quantum of money chasing them.

Causes of Inflation
  1. Over- Expansion of Money Supply: Many a times a remarkable degree of correlation between the increase in money and rise in the price level may be observed. The Central Bank (India’s RBI) should maintain a balance between money supply and production and supply of goods and services in the economy. Money supply exceeds the availability of goods and services in the economy, it would lead to inflation.
  2. Increase in Population: Increase in population leads to increased demand for goods and services.
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Definition of Inflation – Types of Inflation

Definition of Inflation

Inflation is commonly understood as a situation of substantial and rapid general increase in the price level and consequent fall the value of money over a period of time. Inflation means persistent rise in the general level of prices. Inflation is a long term operating dynamic process. By and large, inflation is also a monetary phenomenon. It is usually characterized by an overflow of money and credit. In fact, the root cause of inflation is the expansion of money supply beyond the normal absorbing capacity of the economy. The behavior of general prices is measured through price indices. The trend of price indices reveals the course of inflation or deflation in the economy.

Read More about Inflation:

  • Causes and Effects of Inflation
  • The Stages of Inflation
  • Inflation in a Developing Economy
Definition of Inflation by Different Economists

There is no generally accepted definition of inflation and different economists define it differently.

  • According to Crowther, “Inflation is a ‘state’ is which the value of money is falling i.e. the prices are rising.”
  • According to Milton Friedman, “Inflation is always and everywhere a monetary phenomenon.”
  • According to John Maynard Keynes, “Inflation is the result of the excess of aggregate demand over the available aggregate supply and true inflation starts only after full employment.”
  • According to Paul Samuelson, “Inflation occurs when the general level of prices and costs is rising.”
  • According to Silverman, “Inflation is the name given to the expansion of the money supplies whether in currency or credit in the excess of the amount justified by the government for the trade.”
  • According to Arthur Cecil Pigou, “Inflation exists when income is expanding more than in proportion to the income earning activities.”
  • According to Hanson, “Inflation is present when the volume of purchasing power is persistently running ahead of the output of goods and services so that there is a continuous tendency for prices both for commodities and factors of production to rise because the supply of goods and services and FPO’s fail to keep pace with demand for them.”
  • According to Ackely, “A persistent and appreciable rise in the general level or average of prices.”
  • According to Meyer, “An increase in the prices that occurs after full employment has been attained.”
  • According to Coulbourn, “In inflation, too much money chases too few goods.”
Types of inflation 1.Read the rest

Significance of Money in modern economic life

Money occupies a central position in our modern economy. Money is everywhere and for everything in the modern economic life. Money has become the religion of the day in the ordinary business of life. Every branch of economic activity in a money economy is basically different from what it would have been in a barter economy. Money has created a far reaching effect on all facets of economic activities; consumption, production, exchange and distribution, as also on public finance and economic welfare.

Money and Consumption

Money enables a consumer to generalize his purchasing power. It gives him command over a wide variety of goods. It enables him to canalize his purchasing power and get what he wants. In fact, it is money through its immense purchasing power that makes a consumer sovereign in a capitalist economy. The consumer’s sovereignty can be expressed through money spending. Money provides freedom of choice of consumption. Money and the price mechanism help a consumer to allocate his income over goods in such a way so that he derives maximum satisfaction from his consumption.

Money and Production

The introduction of money has made present day mass production possible. Without money, production on a large scale would be impossible. The benefits of money in production are as follows

  • Money has made extreme division of labour possible. Intensive specialization is necessary for large scale production.
  • Money is the very essential for modern enterprise. Entrepreneurs are concerned, while planning their production activities, with the cost of production and selling prices together with the resulting profit, all calculated in terms of money.
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Important functions of Money

The functions of money can be classified as follows.

1) Money as a medium of exchange

The basic function of money in an economy is to act as a medium of exchange. Money has general acceptability and purchasing power so it can act as a medium of exchange. When money is transacted, purchasing power is transacted from one person to another. In earlier periods we had been following barter system. Barter system means exchanging goods for goods. But most of the time, for such exchange to take place, there must occur a double coincidence of wants. That is each party to the exchange must have precisely what the other party requires, and in an appropriate quantity and at the time required. The use of money as a common medium of exchange has facilitated exchange greatly.

2) Money as a Unit of Account.

Money customarily serves as a common unit of account or measure of value in terms of which the values of all goods and services are expressed. This makes possible meaninigful accounting systems by adding up the values of a wide variety of goods and services whose physical quantities are measured in different units

3) Money as a Standard of Differed Payment

Money also serves as a standard or unit in terms of which deferred or future payments are stated. This applies to payments of interest, rents, salaries; pensions etc.Large fluctuations in the value of money (inflation or deflation) make money not only a poor measure of value, but also a poor standard of deferred payment.… Read the rest

Foreign Institutional Investors (FII’s) and Indian economy

Introduction to Foreign Institutional Investors (FII’s)

Since 1990-91, the Government of India embarked on liberalization and economic reforms with a view of bringing about rapid and substantial economic growth and move towards globalization of the economy. As a part of the reforms process, the Government under its New Industrial Policy revamped its foreign investment policy recognizing the growing importance of foreign direct investment as an instrument of technology transfer, augmentation of foreign exchange reserves and globalization of the Indian economy. Simultaneously, the Government, for the first time, permitted portfolio investments from abroad by foreign institutional investors in the Indian capital market. The entry of FIIs seems to be a follow up of the recommendation of the Narsimhan Committee Report on Financial System. While recommending their entry, the Committee, however did not elaborate on the objectives of the suggested policy. The committee only suggested that the capital market should be gradually opened up to foreign portfolio investments.

From September 14, 1992 with suitable restrictions, Foreign Institutional Investors were permitted to invest in all the securities traded on the primary and secondary markets, including shares, debentures and warrants issued by companies which were listed or were to be listed on the Stock Exchanges in India. While presenting the Budget for 1992-93, the then Finance Minister Dr. Manmohan Singh had announced a proposal to allow reputed foreign investors, such as Pension Funds etc., to invest in Indian capital market.

Market design in India for foreign institutional investors

Foreign Institutional Investors means an institution established or incorporated outside India which proposes to make investment in India in securities.… Read the rest

An overview of Foreign Direct Investment (FDI) in India

About foreign direct investment.

Foreign Direct Investment or FDI is the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution, and other activities of a firm in another country (the host country). The international monetary fund’s balance of payment manual defines FDI as an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor. The investors’ purpose being to have an effective voice in the management of the enterprise’. The united nations 1999 world investment report defines FDI as ‘an investment involving a long term relationship and reflecting a lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor ( FDI enterprise, affiliate enterprise or foreign affiliate).

Foreign direct investment: Indian scenario

FDI is permitted as under the following forms of investments:

  • Through financial collaborations.
  • Through joint ventures and technical collaborations.
  • Through capital markets via Euro issues.
  • Through private placements or preferential allotments.

Forbidden Territories:

  • Arms and ammunition
  • Atomic Energy
  • Coal and lignite
  • Rail Transport
  • Mining of metals like iron, manganese, chrome, gypsum, sulfur, gold, diamonds, copper, zinc.

Foreign Investment through GDRs (Euro Issues):

Indian companies are allowed to raise equity capital in the international market through the issue of Global Depository Receipt (GDRs). GDR investments are treated as FDI and are designated in dollars and are not subject to any ceilings on investment.… Read the rest