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Causes and Effects of Inflation

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Inflation is an increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined, or a relative increase in expenditures as when the supply of goods fails to meet the demand (Webster, 1983). Inflation is a rate which there is a continuous rise in price of goods and services in a country over a period of time. It is happen when there are too much money in the economy chasing after too few goods. The symptoms of the inflation are when all the price of goods and services keep rising and when the currency value in the country start falling. When inflation happen, the purchasing power of people will start falling. The price of goods and services are too high, so people start buying less and consume less.

Every country hope to achieve a low inflation rate but it is not a easy job to realize it. It is same goes to India. India is a country in South Asia. There are about over 1.2 millions of people in India. In 2011 and 2012, India has a high inflation rate in the country. According to the chart ( Appendix 1), in 2011, there is a almost 10% of inflation rate for the year. It is consider as quite high rate of inflation. In 2012, the inflation rate has fall compare to 2011. It is between 6.87% to 8.07%, it is still a high inflation rate.

2.0 Causes of Inflation

2.1 Demand pull inflation

One of the causes of inflation are the population and the demand is rising, the population is 1.22 millions of people in India. When there are too large number of people, the demands of goods and services increases and the goods and services may not enough to supply the people, therefore the price is going up, thus cause the inflation.

2.2 Import cost push inflation

The import cost of goods and services also push the inflation rate to rise. It is because more import than export in the country. When India is reliant on importation of some goods and services from other country, India has to pay all the import costs even if the import costs is too high. Paying import costs also made the money of India keep flowing out from the country, so inflation happen.

2.3 Excessive money supply.

When there are too much money flow in the market, it causes money supply in the market become excessive. It is happen when the stage of boom, people have too much money in hand, so the consumption is increased.

2.4 Expectation

Expectation is occurred when the price of goods and services are expected to rise in the market. Sometimes, it also happen when the neighbour countries are facing the inflation and rising of goods and services. When the price of goods and services become high, inflationm occurs.

3.0 Argument

Although import costs can push inflation, but it doesn't influence much in India. This is because there are many foreign investment or many foreign investors like to open business or build factories in India due to low cost of labour forces and large numbers of labour forces especially in cars manufacturing industry such as Toyota, Bentley, and others are having factories at India. Therefore, the government of India would not need to import so much cars from others countries. There are enough supply of cars in India. Therefore, the government of India can cut down some costs on importation.

4.0 Impact

4.1 Weakening of currency value.

The currency use in Indian is Rupee. Currency value can be says as the exchange rate or the money is cheaper or more expensive compare with others countries.The exchange rate of Indian Rupee (INR) to United State Dollar (USD) 2012 December is about 54.4900 rupee to 1 dollar (Appendix 2). In 2011 December, the exchange rate is about 53.0100 rupee to 1 dollar (Appendix 3). This show the currency value of rupee is still weakening since last year. When the currency is weak, it does not have any value. Indian people will not like to hold the money in hand. When the people spend the money, the inflation rate will rise. This is because many people want to spend the money but they have to chase after too few goods. When this happen, the price of goods and services will definitely rising. The price of goods and services are so high but the currency value is dropping. This results to the money printed is getting larger. For example, in Indian, there are 1000 rupee (Appendix 5) to be printed while Malysia only has RM 100.

4.2 Falling of purchasing power.

Due to continuous price ricing of goods and services, people in Indian has no money to consume the goods and services. Looking at the Consumer Price Index (CPI) at appendix 4, the price of goods and services and ricing for every year. It is getting harder and harder for people to spend or consume on goods and services. For examples, the vegetable being sold on the city of India is about 50 rupee to 55 rupee per kilogram and 20 rupee for the tomato. Therefore, people buy less than before.

4.3 Draw away foreign investment.

Since the inflation happen in India, the foreign investors does not want to operate the business and factory or even invest anything at India. The foreign investors want to invest in a safe condition such as less fluctuation in currency value and more stable on the price of goods and services. The foreign investors want to gain profits or revenue through their investment. If inflation happen, it is hard to ensure the investment bring any profits or revenue for them. When the foreign investment is being drew away, there are less economic growth in India. The job opportunity also decrease and lead to high unemployment rate.

4.4 Cost of living increases.

When the price of goods and services are too high, the cost of living will also increases. There are some neccessity good which every family need it. There are no way to avoid from consuming these goods such as toilet tissue, detergent and others. The price of these goods will also rise. Since it is necessary to every family, although the price is high, people will still buy and consume it. This make the cost of living increases.

4.5 Unemployment rate increases.

When there is an inflation, the business has to cut down the operational and manufacturing cost as much as possible to cover up the high cost of the resources. When this happen, it will lead to unemployment. The business will cut down down some labour force. Many people will lost the jobs. Therefore, the unemployment rate will increases. In December 2011, India has about 9.4% of unemployment (Appendix 6). It is consider as a very high figure. It is also causes by when the foreign investors close up the business due to inflation. It make many workers lost the jobs.

4.6 Slow economic growth.

When inflation happen, the economic growth will be slow. It is because many of the business cannot be expand or even become smaller during this period due to the high cost of the resources and low currency value. Business has no any extra money to boost the economic growth and some even cannot stand with the high price of raw materials and decide to close up part of the business. Therefore, the economic growth will slow down. The economic growth in India

4.7 Argument

Although draw away the foreign investors is one of the impacts which cause by inflation, but it is not obvious in India. It is because the labor forces are very cheap in India. Therefore, many investors still willing to invest in India but they usually invest in the business which exports the goods to other neighbour countries in India and only a little goods to sell at India. For example, some graduates who are Pavan and his classmates are being offered average annual salaries of $7,000 (£4,370), about 15% lower than similar graduates were getting a year ago (Logita Limaya,2012).

4.0 Efforts taken by Government

4.1 Government encourages to reduce interest rate to boost economic growth.

Government of India want to reduce the interest rate which is the interest rate or the borrowing cost to boost the economy growth. The Reserve Bank India (RBI) kept interest rates on hold, ignoring government pressure to reduce borrowing costs, but said it was shifting its focus towards boosting a flagging economy, raising the odds of a rate cut as early as January (SuvashreeDey Choudhury and AradhanaAravindan, 2012). If the interest rate can be reduced, business will have more capital by borrowing the money from the bank to expand the business. Thus, it helps to boost the economic growth.

4.2 Increase the government income and boost economic growth by exporting more cars.

Government wants to increase the number of export on cars. The cars are mostly exported to Sri Lanka. It is hard to increase the exportation because the import tariff of Sri Lanka. Government is negotiating with Sri Lanka by asking them to bring down the import tariff. If the negotiation is successful, the exportation can be increase. When exportation increases, it means there is more job opportunity for the labor forces in India and the unemployment rate can be decreases. The economics of India will also grow up and more income can be generated by the government.

4.3 Open market operation

Open market operation is central bank of India selling or buying bonds, securities, treasury bills and others during inflation. It is to reduce the money flow in the economic so the consumption will be less and inflation rate can be reduces. In Jan 2012, Reserve Bank India (RBI) is open for more open market operation. The government of India and the Reserve Bank India has decided to have more open market operation to reduce the high inflation rate in India by selling the bones, securities or treasury bills to the people. "We are open to more open market operations if the liquidity issue needs to be addressed. The cut in CRR (cash reserve ratio) is purely a liquidity measure. It has put in Rs.32, 000crore," SubirGokarn, deputy governor of Reserve Bank of India (Business, 2012). The example of open market operation done in India is selling government securities (Appendix 7).

5.0 Recommendation

5.1 Control over the formation of monopoly firm.

To reduce the inflation rate, government can control the formation of monopoly firms. In India, there are many monopoly firms which are being formed. For examples, Hindustan Aeronautics Limited (HAL) is monopoly over the production of aircraft, Indian Railway has monopoly on the railway transportation, State Electricity Board has monopoly in the field of electricity in many state and others. Every government does not like the formation of monopoly firms. It is because when there is not other company to compete against these firms, the quality of services or goods will not be improve and the monopoly firms can always increase the price of goods and services as they like. Therefore, government can encourage more firms or companies to set up or compete by borrowing them some loans with conditions.

5.2 Government can provide subsidies on some goods and services.

The prices of goods and services are very high during inflation. People will suffer in paying these goods and services. Therefore, government can make some policy and try to provide subsidies on some price of goods so that people is able to consume it such as sugar, petrol, diesel and others by providing some subsidies. This will help the people so that their living cost can be decreases.

5.3 Government can set the minimum price for imported goods and maximum price for local goods and services.

People like to consume foreign goods or imported goods rather than local goods. It is because imported goods are more branded in the international level. By setting up the maximum price for local goods and services, it may helps the local manufacturer to attract the customers and increase their profits, thus, the income level of the people can be also increases. If the government set the minimum price for the imported goods, less people may buy or consume the imported goods and more people will try and consume the local goods. This may lead to higher economic growth in India. For examples, government can set the minimum price for imported goods like car, electronic device and others while government can set the maximum price for local goods such as daily products, food and others.

7.0 Conclusion

During inflation, currency value is very low and all goods and services are having chain reaction. People will suffer on it and standard of living is dropping. It is hard to decrease the inflation rate in a country and the damage cause is hard to recovery. This is why every country wants to achieve the minimum inflation rate.

In India, Inflation has made the currency value which is rupee to be weaker. The government is not willing to look at this and try to decrease the inflation rate. If the inflation rate continues to rise, the currency value will continue to drop and it may become almost worthless. Purchasing power also affected by the inflation. People will have less purchasing power if the inflation rate is high.

Besides, inflation also draws away the foreign investors. This makes the economy of India to be slowing down. The cost of living in India also increases. Since the prices of goods and services are rising, people of India have no choice but to spend more money on buying these goods and services. Unemployment rate also increases. It is happened when business is cutting down the cost by firing workers or the business is closing up, people lose the jobs.

Government of India has made some effort on controlling the inflation rate to avoid it to increase and even targeting to decrease it. Government has encouraged the Reserve Bank of India (RBI) to reduce the policy rate which is the interest rate to boost the economic growth. It is to lend the loans for business to be expanded.

Moreover, government of India is negotiating with Sri Langka to bring down the car's import tariff so India can export more cars to increase the exportation and government revenue. Government of India and Reserve Bank of India also sells bones, securities, treasury bills and others to reduce the money flow in the economy. When people hold the money in hand, the money will be use or buy things and it makes the inflation more worst. When government has this open market operation, the money will go into bank and no flowing in the economy. It helps to reduce the inflation rate.

In conclusion, there are more strategies or policies can government of India plan to reduce the inflation rate. Government can control over the formation of monopoly firm. If it is successful, there are no ways to let this firm to raise the price as they like. Government also can set a fixed price for some of goods and services by providing some subsidies. It helps to decrease the burden which people have during inflation. Government can set the minimum price for imported goods and maximum price for local goods and services to attract more people on buying the local goods and services.

6.0 Appendix

Appendix 1

Figure 6.1 India Inflation Rate

Appendix 2

Figure 6.2 India Exchange Rate (Monthly)

Appendix 3

Figure 6.3 India Exchange Rate (Yearly)

Appendix 4

Figure 6.4 India Consumer Price Index (CPI)

Appendix 5

Figure 6.5 India Printed Money

Appendix 6

C:\Users\user\Desktop\indexmundi_ex74.jpgFigure 6.6 Unemployment Rate

Appendix 7

Yield based auction of a new security

Maturity Date: September 8, 2018

Coupon: It is determined in the auction (8.22% as shown in the illustration below)

Auction date: September 5, 2008

Auction settlement date: September 8, 2008*

Notified Amount: Rs.1000 crore

* September 6 and 7 being holidays, settlement is done on September 8, 2008 under T+1 cycle.

Figure 6.7 India's Securities Coupon


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