Over Expansion Of Money Supply Economics Essay

Inflation is commonly understood as a situation of considerable and quick general increase in the prices of the currency over a period of time. The general prices are measured through price indices. The trend of prices reveals the course of inflation or deflation. Inflation is statistically measured in terms of percentage increase in the price index- usually a year or a month.

Economist Harry Johnson defines as a “substained rise in price.”

Inflation rises because of rise in the price of the imported commodities like oil, gold, etc….

Effects of Inflation:

Middle class family will be in trouble if a price of things rises faster than their income.

Inflation reduces the value of an investment if returns are inadequate to compensate.

Attack of Inflation often goes hand in hand with inflamed economy.

Sustained inflation also has long-term effects….

If money is losing its value than businessmen and investors will not invest money for long time. This effects on nation’s productive capacity.

It can cause a rapid economic slow-down.

Types of inflation:

There are main 5 catagories which devides inflation in several parts.

According to rate of inflation

According to nature of time-period of occurance

According to the scope or coverages

According to government’s reaction

According to the causes

According to the rate of inflation:

Moderate inflation-(a) creeping inflation (b) walking inflation

Running inflation

Galloping inflation

Hyper inflation

Moderate inflation:

When prices rise by less than 10% (single digit inflation rate) per annum, running inflation occurs. According to Prof. Samuelson, it is a stable inflation and not serious economic problem.

it doesn’t interrupt the economic balance. People’s expectations remain more or less stable in moderate Inflation.

Interest rate is never too low or -ve in this situation so money plays its role as a future investment tool.

Creeping Inflation:

When price rises not more than 3% it is called creeping inflation. It is the mildest form of inflation and also known as a mild inflation or low inflation.

Walking Inflation:

When the rate of rising prices is more than the creeping inflation is known as walking Inflation. When prices rise more than 3% but less than 10% per annum than it’s walking inflation.

Running Inflation:

When the movement of prices speed up rapidly, running inflation emerge. Running inflation may record more than 100% rice in a decade. Thus, when prices rise more than 10% a year, it is called Running Inflation.

Double-digit inflation of 10-20% per annum is called running inflation.

Galloping Inflation:

If prices rise by double or triple digit inflation rates it is called galloping inflation. When prices rise more than 20% and less than 1000%, galloping inflation occurs. It is also referred as JUMPING Inflation. India is facing this inflation since second 5 year plan period.

It is very serious problem. It causes economic distortions and disturbances.

Hyper Inflation:

In this case, prices rise every moment and there is no limit to the height to which prices might rise. Therefore, it is difficult to measure its scale as prices rise by fits and starts.

In statistic terms when prices rise more than 1000% it is caalled Hyper Inflation. There is atleast a 50% price rise in a month so that in year it rises about 130 times.

It represet the pitiable fall in people’s purchasing power. It is generated by immese monetary disorder. It is monetary disease. The velocity circular of money increases very fast.

Causes of Inflation:

Increase in money supply:

Inflation is caused by an increase in the supply of money which leads to increase in demand.higher the growth of nominal money supply, higher the inflation.

Increase in disposable income:

When disposable demand increases demand will increase which will emerge inflation.

Over expansion of money supply:

Remarkable degree of correlation between the increase in money supply and the rise in the price level mayb be observed.

Increase in Exports:

When the demand for domestically produced goods increase in foreign country raises the earnings of the industries producing export commodities.

Cost-push Inflation:

Here the supply of goods and services are stopped for some or other reason while the demand remains unchanged. This push is cost. Generated by the factors like wages, profit and material cost in turn this increases the cost of production and ultimately the price of product and services.

Demand-pull Inflation:

Here people’s demand is continuosly rising and the supply is unchanged or same. Here people are ready to pay for the demanded goods to satisfy their need.

Calculation of inflation:

Inflation can be calculated by many methida but main 3 methods are….

CPI- Consumer Price Index

WPI- Wholesale Price Index

PPI- Product Price Index

CPI- Consumer Price Index

measures changes in the price level of consumer goods and services purchased by households.

It can be used to index the real value of wages, salaries, pensions, for regulagting prices and for deflacting monetory magnitudes to show changes in real value.

CPI=updated cost/base period cost*100

WPI- Wholesale Price Index

WPI is the price of a representative basket of wholesale goods. The indian WPI figure is released every 10 days and influances stock and fixed priced markets.

WPI focuses on the price of goods traded between corporations rather than goods bought by consumers which is measured by CPI.

The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction.

In India WPI is the indicator for inflation rate.

PPI- Product Price Index

This index measures the pressure on producers due to change in cost of raw -materials.

Inflation Rate = (Po-P-1)*100/P-1

Here,

Po= the present average price of goods and services.

P-1=the price of the products and services existed last year.

Trend of inflation since 1991 to 2012

Year

Annual Rate

1990-1991

13.81

1991-1992

11.88

1992-1993

6.31

1993-1994

10.24

1994-1995

10.22

1995-1996

8.98

1996-1997

7.25

1997-1998

13.17

1998-1999

4.84

1999-2000

4.02

2000-2001

2.72

2001-2002

3.8

2002-2003

3.4

2003-2004

5.4

2004-2005

6.4

2005-2006

4.4

2006-2007

5.3

2007-2008

4.7

2008-2009

12.44

2009-2010

10.2

2010-2011

9.4

2011-2012

1.4(till July)

Reasons of the Inlation in 1990s:

Increase in international oil price.

Natural disasters like drought or flood showed an ebbing trend.

The main problem of inflation came to head in August 1990.

When iraq invaded Kuwait the prices of oil doubled in international market.

Trade deficit in 1991 rose to 15600 cores.

India borrowed from IMF.

C:UsersmaitriDownloadsindia-inflation-rate.png

(source: www.google.com)

Reasons for Inflation in early 20th century:

Increase in oil prices twice during the period.

Adverse effects of deficiency of agricultural products led to increase in price of…… Oilseeds and Edible oil.

In 2008, Inflation was because of rise in fuel prices, and rise in prices of primary articles. Global food prices also registered a marked rise during this period.

Trend of Inflation rates since 1991-2012:

In 1990-91, the inflation rate rose by 12.1% and got constant at double digits in consecutive year it means India faced Running Inflation.

Similarly Running Inflation India faced until Inflation rate fall to 5% in 1995-96.

In 1998-99, there was again rise in prices and inflation was there.

In 2002, Inflation was @ its low rating 1.6% but the upward trend become smooth and again the inflation became a cause for concern in the year 2004 when the point to point rise in inflation was 7.7%.

In 2006, the Inflation was so high till the starting months of 2007.

In 2008, infltion was there because of rose in price of oil and primary articles. Food inflation was there in 2008 as India is the primary importer of the food among the world.

In 2009, food grain prices continued to be culprit behind the raising inflation year 2009. There was a great fall from 2008 to 2009 and it was -0.34% if there is negative inflation rate that means purchasing power of people increase but there is lack of supply.

In 2010, there was rose in average rate by 1.64% and in 2011 there was rose of 3.16%.

Correlation between gold price, crude oil price and dollar:

Relation between gold and dollar:

Gold and dollar both are global currancies. Many national banks hold dollars as a reserve currency. They both are considered stable and strong.

If people are worried for the dollar which will may fall iin future than they should invest in gold. The relationship between both of them is inverse. Buying gold and selling dollar will have the effect of moving both prices inversly.

As the dollar’s exchange value falls, it takes more dollar to buy gold so dollar gold price rises. When dollar’s exchange value rises due to any reason it takes fewer dollar to buy a gold.

Gold and dollar relationship is strategic but not tactical. Dollar weknesses always turn into gold strength (in long term) but (in short term) gold and dollar both may can fall or rise together. When inflation rises people buy gold which make gold’s price up.

Weakness of dollar make gold strong in long term scenerio and in short-term scenerio there maybe a condition that dollar and gold will rise and fall together. Whenever inflation comes people buy more and more gold which automatically rise the price of gold.

Realtionship between Crude oil prices and dollar: (Chart from 1977 to 2003)

Year

Yearly Average

1991

$20.19

1992

$19.25

1993

$16.74

1994

$15.66

1995

$16.75

1996

$20.46

1997

$18.97

1998

$11.91

1999

$16.55

2000

$27.40

2001

$23.00

2002

$22.81

2003

$27.69

2004

$37.41

2005

$50.04

2006

$58.30

2007

$64.20

2008

$91.48

2009

$53.56

2010

$71.21

2011

$87.48

2012

$83.7 (estimated)

Recent trend of crude oil and dollar: (8/18/2012)

DX_CL_Correlation.jpg

Increasing oil price results in increase of inflation. It impacts economy negatively. Higer oil prices are reflected in virtually every finished product as well as food and commodities in general. Crude oil is mainly traded in US dollar and when US dollar prices weakens the crude oil participants push the price of crude higher on the expectations.

Effects on demand:

Oil purchases are paid in dollars. However demand is dependednt on the domestic price of country which always fluctuate with chnages in dollar. So dollar depreciation reduces the oil price in domestic currancy.

This leads to an increase in their real income and an increase in their oil demand. Therefore, the dollar depreciation a priori has a positive impact on oil demand and should contribute to raise the price.

Effects on supply:

Dollar changes affect the price as supposed by the producers less than the one apparent by demanders. Dollar depreciation can activate inflation and income in oil producer countries, the currencies which are linked to US dolalr.

The increase in inflation and the decrease in purchasing power reduce the real disposable income and therefore the income available for drilling, everything else equals. Overall, a dollar depreciation may result in a reduction in oil supply.

Overall, depreciation of dollar causes an increase in oil demand and a reduction in supply, mainly on the long run, which tends to boost oil price.

Realtionship between Gold, Crude oil and dollar in inflation:

An increase in oil price resukts in inflation which affects the countries those importing oil.it affects the prices in general economy. According to a study, the global resource of oil is depleting at an annual rate of 6 per cent while demand is growing at an annual rate of 2 per cent.

Era of cheap oil is over now but now we have to see impact of oil prices on dollar and gold. Up to 1971 central banks were giving facility of converting dollar into gold. When this facility was removed, oil producing countries converted dollar into gold.

There is positive relation between gold and oil since last 5 years. With recent increase in oil, relationship between gold n oil is not moving in cycle. if the price of oil increase due to supply and demand mismatch and dollar declines than gold/silver price will increase.