Topics: Inflation, Monetary policy, Economics Pages: 5 (1754 words) Published: November 8, 2014
The government control measures, all over the world, keep business cycles under control. What has gone nearly uncontrolled over the time is the problem of almost continuous increase in the general price level (this is the problem of inflation). The problem of inflation got accentuated since the early 1970s. It emerged as the most intractable economic problem for both theoreticians and policy-makeovers all over the world. Inflation has been a common problem of the developed and the developing economies. “Inflation means generally a considerable and persistent rise in the general level of prices or the cost of living.” A decline in the value of money.

The general tendency in changes of prices of goods and services over a time is called price level. The sustained rise in general price level is called inflation. During the period of inflation, purchasing power of money declines. When the general price level rises, each unit of currency buys fewer goods and services. Inflation reflects reduction in purchasing power per unit of money But, falling inflation does not mean falling prices and a slowdown in inflation does not mean deflation, for it to happen inflation has to be negative. A modern rate of inflation is considered to be desirable for the economy. The limit of desirable inflation varies from country to country and from time to time. Based on past experience, it is sometimes suggested that 1-2% inflation in developed countries and 4-6% inflation in less developed countries is appropriate and desirable limit of modern inflation. So as long as:-

The general level of price rises at an annual average rate of 2-3% in developed countries and 4-5% in less developed countries and Macro-variables are not adversely affected by price rise; policy measures to control inflation are not required because controlling inflation under these conditions may distort the price system and disturb employment and growth process. A price rise is not considered inflationary under the following conditions:- When prices tend to rise due to change in the composition of GDP, it is not inflationary. (During the period of economic growth, the proportion of low price goods like agricultural products decreases and that of high-priced goods e.g. - cars, TV sets, computers, superior housing, increases causing a high rise in price index number. This rise in price is not inflation. Price rise due to qualitative change in products is not inflation. (For eg- in case of cars, the brand new car may have qualitative improvement in the form of AC facility, automatic gear system and power brake etc., such qualitative changes involve increase in cost of production and therefore cause a rise in price. But, it is not inflation.) Short-run rise in price due to sudden increase in demand and/or decrease in supply is not inflation.(price rise under conditions like demand increase or supply decrease due to reasons like crop failure, strikes and lockouts, pre-budget speculations, disruption of foreign supply due to war etc. the price rise under such conditions is not supposed to be a persistent increase in the price level.) Price rise after depression or recession is not inflationary.(prices tend to rise during the phase of recovery after a short-run depression or recession to reach their normal level. Such a price rise is not inflation, even if it is persistent and appreciable.) METHODS OF MEASURING INFLATION:-

There are two methods of measuring inflation:-
1. By computing change in price index numbers (PINs)
2. Comparing the change in GDP deflator.
Thru PINs-
Rate of inflation= {(PINt-PINt-1)/ PINt-1 } *100
PINt is the price index number for the year selected for inflation calculation and the (t-1) PIN is of the preceding year. E.g.:- WPi for ’99-2000 was 150.9 and 159.2 for ’00-2001. So Rate of inflation for ’00-2001 was 5.5% For an easy to see example suppose the CPI on 1/1/78 was 107 and on 1/1/77 it was 100: 107 / 100 = 1.07 - 1.0 = 0.07 x...
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