Other Related Concepts

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  1. Inflation - It refers to the persistent rise in the general price level, i.e., in the price of goods and services when compared to base year prices.
  2. Deflation - It refers to the persistent fall in the general price level, below the base level prices. The rate of change of price index is negative here.
  3. Disinflation - It is persistent fall in price levels, but prices are still above the base year prices, the rate of change of price index is still positive.
  4. Reflation - It is a deliberate action taken by government to stimulate economy during deflationary conditions.
  5. Classification of Inflation based on Rate
    • Creeping Inflation: below 3%
    • Walking Inflation: 3% to 10 %
    • Running Inflation: 10% to 20%
    • Galloping Inflation: above 20%
    • Hyper Inflation: This form of inflation is ‘large and accelerating’ which might have the annual rates in million or even trillion. In such inflation not only the range of increase is very large, but the increase takes place in a very short span of time, prices shoot up overnight. Such an inflation quickly leads to a complete loss of confidence in the domestic currency.
  6. Bottleneck Inflation
    • This inflation takes place when the supply falls drastically and the demand remains at the same level. Such situations arise due to supply-side hurdles, hazards or mismanagement which is also known as ‘structural inflation’.
    • Structural Issue in India.
      • Skipping Manufacture Sector.
      • Disproportion share of workers (Ex: Agri share in GDP is 18% but work force in Agriculture is above 50%).
      • Persisting unemployment.
      • Less Infrastructure (Road, Transport, Ports).
  7. Skewflation
    • Economists usually distinguish between inflation and a relative price increase. ‘Inflation’ refers to a sustained, across-the-board price increase, whereas ‘a relative price increase’ is a reference to an episodic price rise pertaining to one or a small group of commodities.
    • This leaves a third phenomenon called skewflation, namely one in which there is a price rise of one or a small group of commodities over a sustained period of time.
    • This skews the value of inflation, hence called skewflation.
    • Ex: CPI (C) has food 46% value in food (It consist of many items Vegetable, Fruits etc...) – Increase onion price in vegetable, it also increases whole Inflation value of CPI (C). Skewflation is find the good which cause inflation and Govt take action (Administrative Measure) specific to the good, not as whole Economy. And solve the Inflation.
  8. Core Inflation
    • This nomenclature is based on the inclusion or exclusion of the goods and services while calculating inflation. Core inflation shows price rise in all goods and services excluding energy and food articles which are often volatile in nature and skews the value of Inflation.
Headline Inflation
Core Inflation
Total inflation within an Economy include all Commodities   (Food, oil which prone to Inflationary Spike).
Core inflation within an Economy exclude some Commodities   which is volatile in nature (Price of vegetable, fruit, oil etc...)
Maintain: 2% - 6%.
  1. Inflationary Gap
    • Potential GDP – Assume if Unemployment is Zero. Calculate the GDP Value.
    • (Inflationary Gap - Nominal GDP exceed than the potential GDP.
      • Case 1: Reach 100% employment cause GDP growth is Good.
      • Case 2: Due to High Inflation, GDP growth (Unemployment Same) – Is Bad for Economy.
    • Deflationary Gap - Gap Between Nominal GDP & Potential GDP)
      • The excess of total government spending above the national income (i.e., fiscal deficit) is known as inflationary gap. This is intended to increase the production level, which ultimately pushes the prices up due to extra-creation of money during the process.
  2. Inflation Tax – (Not a tax, it’s an effect).
    • Inflation erodes the value of money and the people who hold currency suffer in this process. As the governments have authority of printing currency and circulating it into the economy (as they do in the case of deficit financing), this act functions as an income to the governments. This is a situation of sustaining government expenditure at the cost of people’s income, that cause inflation. This looks as if inflation is working as a tax.
    • Simply, Inflation (reduce value of money) caused by More government expenditure (High disposal Income to people) is called Inflation Tax.
    • Inflation Induced Tax – Inflation cause through increase of Government tax.
  3. Phillips Curve
    • The inverse relationship between unemployment rate and inflation when graphically charted is called the Phillips curve.
    • The theory states that the higher the rate of inflation, the lower the unemployment and vice-versa.
    • Thus, high levels of employment can be achieved only at high levels of inflation.
    • The implications of Phillips curve have been found to be true only in the short term.
    • Phillips curve fails to justify the situations of stagflation, when both inflation and unemployment are alarmingly high.
    • Phillips curve (for Ideal State)- Inflation is inversely proportional to unemployment
    • Some Exception like India
      • Jobless Growth - India skipped manufacture sector, service sector give growth to economy, but less jobs in Service sector. India break phillips curve (Inflation and unemployment high).
      • Stagflation.
  1. Stagflation
    • Stagflation is a situation in an economy when inflation and unemployment both are at higher levels, contrary to conventional belief as given by Phillips Curve. (low growth rate [Unemployment] & High Inflation [high food price]).
    • It was proposed by Milton Friedman.
  2. Inflation Premium
    • The bonus brought by inflation to the borrowers is known as the inflation premium.
    • The interest banks charge on their lending is known as the nominal interest rate, which might not be the real cost of borrowing paid by the borrower to the banks.
    • To calculate the real cost a borrower is paying on its loan, the nominal rate of interest is adjusted with the effect of inflation and thus the interest rate we get is known as the real interest rate.
    • Real interest is always lower than the nominal interest rate, if the inflation is taking place—the difference is the inflation premium.
    • Additional premium enjoyed by debtors (Refer Creditors and Debtors example on Impact of Inflation)
  3. Base Effect
    • Impact of base year prices on the rate of inflation.
    • It refers to the impact of the rise in price level in the previous year (i.e., last year’s inflation) over the corresponding rise in price levels in the current year (i.e., current inflation).
    • If the price index had risen at a high rate in the corresponding period of the previous year, leading to a high inflation rate, some of the potential rise is already factored in, therefore, a similar absolute increase in the Price index in the current year will lead to a relatively lower inflation rates.
    • On the other hand, if the inflation rate was too low in the corresponding period of the previous year, even a relatively smaller rise in the Price Index will arithmetically give a high rate of current inflation.
Consider the two Cases example for Base effect
  •  Case 1
    • Price index on 7th January, 2007 = 110
    • Price index on 7th January, 2008 = 120
    • Rate of inflation on 7 January, 2008 = 120
      • 110/110 * 100 = 9.09 %
  • Case 2
    • Price index on 10th March, 2008 = 180
    • Price index on 10th March, 2009 = 190
    • Rate of inflation on 10th March, 2009 = 190.
      • 180/180 *100 = 5.55%
In both the cases, the index number increased by 10, but the rate of inflation is different The rate of inflation is low in second case compared to first case. This is because of the difference in base period index.

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