Introduction

Inflation is one of the most frequently used terms in economic discussions, yet the concept is
variously misconstrued. There are various schools of thought on inflation, but there is a
consensus among economists that inflation is a continuous rise in the prices. Simply put, inflation
depicts an economic situation where there is a general rise in the prices of goods and services,
continuously. It could be defined as ‘a continuing rise in prices as measured by an index such as
the consumer price index (CPI) or by the implicit price deflator for Gross National Product
(GNP). Inflation is frequently described as a state where “too much money is chasing too few
goods”. When there is inflation, the currency loses purchasing power. The purchasing power of a
given amount of Rs. will be smaller over time when there is inflation in the economy. For
instance, if we assume that Rs.1000 can purchase 10 shirts in the current period, if the price of
shirts doubles in the next period, the same Rs.1000 can only afford 5 shirts.
In the definition of inflation, two key words must be borne in mind. First, is aggregate or general,
which implies that the rise in prices that constitutes inflation must cover the entire basket of
goods in the economy as distinct from an isolated rise in the prices of a single commodity or
group of commodities? The implication here is that changes in the individual prices or any
combination of the prices cannot be considered as the occurrence of inflation. However, a
situation may arise such that a change in an individual price could cause the other prices to rise..
This again does not signal inflation unless the price adjustment in the basket is such that the
aggregate price level is induced to rise. Second, the rise in the aggregate level of prices must be
continuous for inflation to be said to have occurred. The aggregate price level must show a
tendency of a sustained and continuous rise over different time periods. This must be separated
from a situation of a one-off rise in the price level.

Related definitions

The term "inflation" usually refers to a measured rise in a broad price index that represents the
overall level of prices in goods and services in the economy. The Consumer Price Index
(CPI), the Personal Consumption Expenditures Price Index (PCEPI) and the GDP
deflator are some examples of broad price indices. The term inflation may also be used to
describe the rising level of prices in a narrow set of assets, goods or services within the
economy, such as commodities (which include food, fuel, metals), financial assets (such
 as stocks, bonds and real estate), and services (such as entertainment and health care). The
Reuters-CRB Index (CCI), the Producer Price Index, and Employment Cost Index
(ECI) are examples of narrow price indices used to measure price inflation in particular
sectors of the economy. Asset price inflation is a rise in the price of assets, as opposed to
goods and services. Core inflation is a measure of price fluctuations in a sub-set of the
broad price index which excludes food and energy prices. The Federal Reserve Board
uses the core inflation rate to measure overall inflation, eliminating food and energy prices
to mitigate against short term price fluctuations that could distort estimates of future long
term inflation trends in the general economy.

Methods to measure the inflation

a. Consumer Price Index (CPI)

A consumer price index (CPI) is a measure estimating the average price of consumer goods and
services purchased by households. A consumer price index measures a price change for a
constant market basket of goods and services from one period to the next within the same area
(city, region, or nation). It is a price index determined by measuring the price of a standard group
of goods meant to represent the typical market basket of a typical urban consumer. Related, but
different, terms are the United Kingdom's CPI, RPI, and RPIX. It is one of several price indices
calculated by most national statistical agencies. The percent change in the CPI is a measure
estimating inflation. The CPI can be used to index (i.e., adjust for the effects of inflation) wages,
salaries, pensions, and regulated or contracted prices. The CPI is, along with the population
census and the National Income and Product Accounts, one of the most closely watched national
economic statistics. The index is usually computed yearly, or quarterly in some countries, as a
weighted average of sub-indices for different components of consumer expenditure, such as food,
housing, clothing, each of which is in turn a weighted average of sub-sub-indices.

b. Wholesale Price Index (WPI)

A Wholesale Price Index (WPI) is the price of a representative basket of wholesale goods.
Some countries (like India and The Philippines) use WPI changes as a central measure of
inflation. However, India and the United States now report a producer price index instead.
The Wholesale Price Index or WPI is the price of a representative basket of wholesale goods.
Some countries use the changes in this index to measure inflation in their economies, in
particular India – The Indian WPI figure is released weekly on every Thursday and influences
stock and fixed price markets. The Wholesale Price Index focuses on the price of goods traded
between corporations, rather than goods bought by consumers, which is measured by the
Consumer Price Index. The purpose of the WPI is to monitor price movements that reflect supply
and demand in industry, manufacturing and construction. This helps in analyzing both
macroeconomic and microeconomic conditions. The wholesale price index consists of over 2,400
commodities. But in India it consists of 435 commodities. The indicator tracks the price
movement of each commodity individually. Based on this individual movement, the WPI is
determined through the averaging principle.

Types of Inflation

A) On the basis of period of occurrence

1. War-Time Inflation

It is the outcome of certain exigencies of war, on account of increased government expenditure

on defense which is of an unproductive nature. By such public expenditure, the government
apportions a substantial production of goods and services out of total availability for war which
causes a downward shift in the supply; as a result, an inflationary gap may develop.

2. Post-war Inflation
It is a legacy of war. In the immediate post-war period, it is usually experienced. This may
happen when the disposable income of the community increases, when war-time taxation is
withdrawn or public debt is repaid in the post-war period.

3. Peace-time Inflation
By this is meant the rise in prices during the normal period of peace. Peacetime inflation is often
a result of increased government outlays on capital projects having a long gestation period; so a
gap between money income and real wage goods develops. In a planning era, thus, when
government’s expenditure increases, prices may rise.
B) On the basis of rise in prices

1. Creeping Inflation:
This occurs when the rise in price is very slow. A sustained annual rise in prices of less than 3
per cent per annum falls under this category. Such an increase in prices is regarded safe and
essential for economic growth. Inflation at a moderate rate, but persist over long periods. This is
the normal state of affairs in many countries

2. Walking Inflation:
Walking inflation occurs when prices rise moderately and annual inflation rate is a single digit.
This occurs when the rate of rise in prices is in the intermediate range of 3 to less than 10 per
cent. Inflation of this rate is a warning signal for the government to control it before it turns into
running inflation.

3. Running Inflation:
When prices rise rapidly at the rate of 10 to 20 per cent per annum, it is called running inflation.
This type of inflation has tremendous adverse effects on the poor and middle class. Its control
requires strong monetary and fiscal measures.

4. Hyperinflation:
Hyperinflation occurs when prices rise very fast at double or triple digit rates. This could get to a
situation where the inflation rate can no longer be measurable and absolutely uncontrollable.
Prices could rise many times every day. Such a situation brings a total collapse of the monetary
system because of the continuous fall in the purchasing power of money.

C) On the basis of degree of control

1. Open Inflation
When the government does not attempt to prevent a price rise, inflation is said to be open. Thus,
inflation is open when prices rise without any interruption. In open inflation, the free market
mechanism is permitted to fulfill its historic function of rationing the short supply of goods and
distribute them according to consumer’s ability to pay. Therefore, the essential characteristics of
an open inflation lie in the operation of the price mechanism as the sole distributing agent. The
post-war hyperinflation during the twenties in Germany is a living Example of open inflation.

2. Suppressed Inflation
When the government interrupts a price rise there is a ‘repressed or suppressed’ inflation. Thus,
suppressed inflation refers to those conditions in which price increases are prevented at the
present time through an adoption of certain measures like price controls and rationing by the
government, but they rise on the removal of such controls and rationing. The essential
characteristic of repressed inflation, in contrast to open inflation, is that the former seeks to
prevent distribution through price rise under free market mechanism and substitutes instead a
distribution system based on controls. Thus, the administration of controls is an important feature
of suppressed Inflation. However, many economists like Milton and G.N.Halm opine that if there
has to be any inflation, it is better open than suppressed. Suppressed inflation is condemned as it
breeds number of evils like black market, hierarchy of price controllers and rationing officers,
and uneconomic diversion of productive resources from essential industries to non-essential or
less essential goods industries since there is a free price movement in the latter and hence are
more profitable to investors.

According to causes

a. Demand-Pull Inflation
According to the demand-pull theory, prices rise in response to an excess of aggregate demand
over existing supply of goods and services. The demand-pull theorists point out that inflation
(demand-pull) might be caused, in the first place, by an increase in the quantity of money, when
the economy is operating at full employment level. As the quantity of money increases, the rate
of interest will fall and, consequently, investment will increase. This increased investment
expenditure will soon increase the income of the various factors of production. As a result,
aggregate consumption expenditure will increase leading to an effective increase in the effective
demand. With the economy already operating at the level of full employment, this will
immediately raise prices, and inflationary forces may emerge. Thus, when the general monetary
demand rises faster than the general supply, it pulls up prices (commodity prices as well as factor
prices, in general). Demand-pull inflation, therefore, manifest it when there is active cooperation,
or passive collusion, or a failure to take counteracting measures by monetary authorities.
Demand-pull or just demand inflation may be defined as a situation where the total monetary
demand persistently exceeds total supply of real goods and services at current prices, so that
prices are pulled upwards by the continuous upward shift of the aggregate demand function.

Causes of Demand-Pull Inflation

It should be noted that the concept of demand-pull inflation is associated with a situation of full
employment where increase in aggregate demand cannot be met by a corresponding expansion in
the supply of real output. There can be many reasons for such excess monetary demand:
1. Increase in Public Expenditure. There may be an increase in the public expenditure (G) in
excess of public revenue. This might have been made possible (or rendered necessary) through
public borrowings from banks or through deficit financing, which implies an increase in the
money supply.
2. Increase in Investment. There may be an increase in the autonomous investment (iI in firms,
which is in excess of the current savings in the economy. Hence, the flow of total expenditure
tends to rise, causing an excess monetary demand, leading to an upward pressure on prices.
3. Increase in MPC. There may be an increase in the marginal propensity to consume (MPC),
causing an excess monetary demand. This could be due to the operation of demonstration effect
and such other reasons.
4. Increasing Exports and Surplus Balance of Payments. In an open economy, an increasing
surplus in the balance of payments also leads to an excess demand. Increasing exports also have
an inflationary impact because there is generation of money income in the home economy due to
export earnings but, simultaneously, there is reduction in
the domestic supply of goods because products are exported. If an export surplus is not balanced
by increased savings, or through taxation, domestic spending will be in excess of the value of
domestic output, marketed at current prices.
5. Diversification of Goods. A diversion of resources from the consumption goods sector either
to the capital goods sector or the military sector (for producing war goods) will lead to an
inflationary pressure because while the generation of income and expenditure continues, the
current flow of real—output decreases on account of high gestation period involved in these
sectors. Again, the opportunity cost of war goods is quite high in terms of consumption goods
meant for the civilian sector. This leads to an excessive monetary demand for the goods and
services against their real supply, causing the prices to move up.
In short, it is said that the demand-pull inflation could be averted through deflationary measures
adopted by the monetary and fiscal authorities. Thus, passive policies are responsible for
demand-pull inflation.

b. Cost-Push Inflation
A group of economists hold the opposite view that the process of inflation is initiated not by an
excess of general demand but by an increase in costs, as factors of production try to increase their
share of the total product by raising their prices. Thus, it has been viewed that a rise in prices is
initiated by growing factor costs. Therefore, such a price rise is termed as “cost-push” inflation
as prices are being pushed up by the rising factor costs.
1. Wage- push: It is believed that wages constitute nearly seventy per cent of the total cost of
production. This is especially true for a country like India, where labor intensive techniques are
commonly used. Thus, a rise in wages leads to a rise in the total cost of production and a
consequent rise in the price level, because fundamentally, prices are based on costs. It has been
said that a rise in wages causing a rise in prices may, in turn, generate an inflationary spiral
because an increase would motivate the workers to demand higher wages. Indeed, any
autonomous increase in costs. Basically, however, it is wage-push pressures which tend to
accelerate the rising price spiral. Cost-push analysis assumes monopoly elements either in the
labor market or in the product market. When there are monopolistic labor organizations, prices
may rise due to wage-push.

2. Profit-push: when there are monopolies in the product market, the monopolists may be
induced to raise the prices. In order to fetch high profits there is profit-push in raising the prices.
However, the cost-push hypothesis rarely considers autonomous attempts to increase profits as
an important inflationary element. Firstly, because profits are generally a small fraction of the
total price, a rise in profits would have only a slight impact on prices. Secondly, the monopolists
generally hesitate to raise prices in absence of obvious demand-pull elements. Finally, the
motivation for profit-push is weak since, at least in corporations, those who make the decision to
raise prices are not the direct beneficiaries of the price increase. Hence cost-push is generally
conceived as a synonymous with wage-push. When wages are pushed up, cost of production
increases to a considerable extent so that prices may rise. Since wages are pushed up by the
demand for high wages by the labor unions, wage-push may be .equated with union-push.

According to one variant of the cost-push theory, sectored shifts in demand are prime-movers in
the inflationary process. Starting with an autonomous shift in demand, a rise in wages and prices
could result in one sector and this rise could elicit further shifts of demand. This happens because
there is a close link between different goods through inputs. One good serves as an input in the
production of the other goods, and consequently, when the price of the input rises, the prices of
output will also rise. For instance, when due to a rise in wages in the steel industry, price of steel
may rise, and this will raise the prices of vehicles, machines, etc., using Steel as input. The rise in
the prices of vehicles may in turn raise the cost of transport and manufactured goods. Similarly,
prices of tractors, etc. may increase due to high prices of steel so that costs of agriculture may
raise, hence food and raw material prices will also rise. All these ultimately raise the cost of
living, leading to increase in wage rates. Thus, inflation once sets in motion due to the
phenomenon of cost-push in one industry or sector spreads throughout the economy.

Inflation rate
The inflation rate is the percentage by which prices of goods and services rise beyond their
average levels. It is the rate by which the purchasing power of the people in a particular
geography has declined in a specified period. The rate of inflation may be calculated weekly,
monthly or annually. However, it is always expressed as an annualized figure.
In economics, the inflation rate is a measure of inflation, the rate of increase of a price index (for
example, a consumer price index).It is the percentage rate of change in price level over time. The
rate of decrease in the purchasing power of money is approximately equal.
It's used to calculate the real interest rate, as well as real increases in wages, and official
measurements of this rate act as input variables to COLA adjustments and Inflation derivatives
prices.
The rate is usually expressed in annualized terms, though the measurement periods are usually
different from one year. Inflation rates are often given in seasonally adjusted terms, removing
systematic quarter-to-quarter variation.
Methods of calculating the inflation rate
The two main methods used to calculate the inflation rate are:
Base period: This method is the more common of the two and assigns a relative weight to each
element while making calculations.
 Chained measurements: In this method, the contents of the ‘commodity bundle’ are
adjusted, along with the prices. Besides, individual time periods in which the price levels
fluctuate are also taken into account.
Any undesired change in the rate of inflation can affect the economy and national development at
large. The appropriate estimation of inflation rates is necessary to get an overview of the national
economy.

Inflation rate: the formula

The equation to calculate the inflation rate is:
Inflation Rate = (Po- P-1)* 100 / P-1,
Where
Po = the present average price
P-1 = the price that existed last year.
The inflation rate is always stated as a percentage. Another way of calculating the inflation rate is
to apply the log rule. The inflation rate is important, since it is subtracted from various economic
rates in order to eliminate the impact of inflation. The real increase in wages is also counted by
taking into account the prevailing inflation rate.

Inflation rate: indices

The inflation rate can be calculated for different price indices. For the national inflation rate, the
consumer price index (CPI) is considered. This index measures the actual prices of goods and
services needed by the common man. The inflation rate can also be measured by the following
indices:
 Cost-of-living index (COLI):This is used to adjust income scales so that the real value of
earnings remains the same.
 Producer price index (earlier Wholesale Price Index): This measures the average change
in prices that domestic producers receive for their products. This index measures the growing
pressure on producers due to changes in the costs of their raw materials. This pressure might get
passed on to consumers, absorbed by profits or offset by a rise in productivity.
 Commodity price index: This measures the prices of a selected group of commodities.
 Core price index: This removes the volatile components (primarily food and oil) from
broader indices, like the CPI. Short term changes in demand and supply conditions do not
significantly affect such indices. Central banks use it to assess the need for adjusting the
monetary policy.

Measures
Inflation is usually estimated by calculating the inflation rate of a price index, usually the
Consumer Price Index. The Consumer Price Index measures prices of a selection of goods and
services purchased by a "typical consumer”. The inflation rate is the percentage rate of change of
a price index over time.
For example, If the Consumer Price Index was 202.416in last year, and now it is 211.080. The
formula for calculating the annual percentage rate inflation in the CPI over the course last year is

The resulting inflation rate for the CPI in this one year period is 4.28%, meaning the general
level of prices for typical consumers rose by approximately four percent in last year.
Other widely used price indices for calculating price inflation include the following:
• Cost-of-living indices (COLI) are indices similar to the CPI which are often used to
adjust fixed incomes and contractual incomes to maintain the real value of those incomes.
• Producer price indices (PPIs) which measures average changes in prices received by
domestic producers for their output. This differs from the CPI in that price subsidization,
profits, and taxes may cause the amount received by the producer to differ from what the
consumer paid. There is also typically a delay between an increase in the PPI and any
eventual increase in the CPI. Producer price index measures the pressure being put on
producers by the costs of their raw materials. This could be "passed on" to consumers, or
it could be absorbed by profits, or offset by increasing productivity. In India and the
United States, an earlier version of the PPI was called the Wholesale Price Index.
 • Commodity price indices, which measure the price of a selection of commodities. In the
present commodity price indices are weighted by the relative importance of the
components to the "all in" cost of an employee.
• Core price indices: because food and oil prices can change quickly due to changes in
supply and demand conditions in the food and oil markets, it can be difficult to detect the
long run trend in price levels when those prices are included. Therefore most statistical
agencies also report a measure of 'core inflation', which removes the most volatile
components (such as food and oil) from a broad price index like the CPI. Because core
inflation is less affected by short run supply and demand conditions in specific markets,
central banks rely on it to better measure the inflationary impact of current monetary
policy.
Other common measures of inflation are:
• GDP deflator is a measure of the price of all the goods and services included in Gross
Domestic Product (GDP). The US Commerce Department publishes a deflator series for
US GDP, defined as its nominal GDP measure divided by its real GDP measure.
• Regional inflation The Bureau of Labor Statistics breaks down CPI-U calculations down
to different regions of the US.
• Historical inflation before collecting consistent econometric data became standard for
governments, and for the purpose of comparing absolute, rather than relative standards of
living, various economists have calculated imputed inflation figures. Most inflation data
before the early 20th century is imputed based on the known costs of goods, rather than
compiled at the time. It is also used to adjust for the differences in real standard of living
for the presence of technology.
• Asset price inflation is an undue increase in the prices of real or financial assets, such as
stock (equity) and real estate. While there is no widely-accepted index of this type, some central
bankers have suggested that it would be better to aim at stabilizing a wider general price level
inflation measure that includes some asset prices, instead of stabilizing CPI or core inflation
only. The reason is that by raising interest rates when stock prices or real estate prices rise, and
lowering them when these asset prices fall, central banks might be more successful in avoiding
bubbles and crashes in asset prices.
Issues in measuring
Measuring inflation in an economy requires objective means of differentiating changes in
nominal prices on a common set of goods and services, and distinguishing them from those price
shifts resulting from changes in value such as volume, quality, or performance. For example, if
the price of a 10 oz. can of corn changes from $0.90 to $1.00 over the course of a year, with no
change in quality, then this price difference represents inflation. This single price change would
not, however, represent general inflation in an overall economy. To measure overall inflation, the
price change of a large "basket" of representative goods and services is measured. This is the
purpose of a price index, which is the combined price of a "basket" of many goods and services.
The combined price is the sum of the weighted average prices of items in the "basket". A
weighted price is calculated by multiplying the unit price of an item to the number of those items
the average consumer purchases. Weighted pricing is a necessary means to measuring the impact
of individual unit price changes on the economy's overall inflation. The Consumer Price Index,
for example, uses data collected by surveying households to determine what proportion of the
typical consumer's overall spending is spent on specific goods and services, and weights the
average prices of those items accordingly. Those weighted average prices are combined to
calculate the overall price. To better relate price changes over time, indexes typically choose a
"base year" price and assign it a value of 100. Index prices in subsequent years are then
expressed in relation to the base year price.
Inflation measures are often modified over time, either for the relative weight of goods in the
basket, or in the way in which goods and services from the present are compared with goods and
services from the past. Over time adjustments are made to the type of goods and services selected
in order to reflect changes in the sorts of goods and services purchased by 'typical consumers'.
New products may be introduced, older products disappear, the quality of existing products may
change, and consumer preferences can shift. Both the sorts of goods and services which are
included in the "basket" and the weighted price used in inflation measures will be changed over
time in order to keep pace with the changing marketplace.
Inflation numbers are often seasonally adjusted in order to differentiate expected cyclical cost
shifts. For example, home heating costs are expected to rise in colder months, and seasonal
adjustments are often used when measuring for inflation to compensate for cyclical spikes in
energy or fuel demand. Inflation numbers may be averaged or otherwise subjected to statistical
techniques in order to remove statistical noise and volatility of individual prices.
When looking at inflation economic institutions may focus only on certain kinds of prices, or
special indices, such as the core inflation index which is used by central banks to formulate
monetary policy.

Causes of inflation
The research on the causes of inflation has been done by two schools. The first school of
economists is known as the 'monetarists' who stress on the influence of money on the rate of
inflation and the other school is known as 'Keynesians' who emphasize on the monetary effect
along with the interest rates and output influencing inflation level. There is another school known
as the Austrian School of Economics who believe that the supply of money controls the rate of
inflation. The different schools of economists could never find a universal solution to the
problem of finding out the causes for inflation but they are can be divided into two broad
categories:
• Quantity Theories of Inflation
• Quality Theories of Inflation
David Hume and Adam Smith dually introduced two theories: Quality theory of inflation for
production and a Quantity theory of inflation for money. There is an existence of a Triangle
Model in economics which defines the causes behind inflation. This was introduced by Robert J
Gordon. The triangle consists of three factors. They are:
• Demand-Pull Inflation- in this the inflation is caused due to the increase in demand.
• Cost-Push- this inflation is caused due to the increase in supply and the decrease n
production.
• Built-In Inflation-this inflation is caused due to the conflict between the workers who
demand higher wage and the owners who pass on this burden to the consumers to
compensate their expenditure.

The main cause behind inflation is the increase of money supply than the demand for money.
Alternatively, it can be said that when the supply of money per unit of output increases, inflation
occurs. The supply of money per unit of output increases, when "velocity" of money circulation
increases. The demand for money depends on the overall economic activities of a country.
There are several reasons as to why an economy can experience inflation:

1. Demand-Pull Inflation, which states that all sectors in the economy try to buy more than the
economy can produce. Shortages are then created and merchants lose business. To compensate,
some merchants raise their prices. Others don't offer discounts or sales. In the end, the price level
rises. This is one of the main causes of inflation seen by any economy. When a commodity
experiences a demand that is much higher than the supply, the prices will definitely go up,
making the commodity more expensive. On a broader scale, when the economy of a country is
not able to fulfill the demands of the market in relation to the goods and services, the price of the
goods and services go up, resulting in depreciation in the buying power of money.

2. Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain
their profit margins. Increased costs can include things such as wages, taxes, or increased costs of
imports. In this type of inflation the prices of the products and services go up due to the increase
in the cost factor behind them. This increment is observed mainly due to the hike in the employee
wages of potential companies. Such increase in the wages is generally a result of the influential
employers and labor unions of large companies.

3. If interest rates increase, inflation can occur. The cost to borrow money goes up for
businesses, increasing their cost and so on. However, higher interest rates also encourage people
to save more and spend less, shortening demand and lowering prices on items.
The following factors can also lead to inflation:
• Printing too much money. This is called a loose or expansionary monetary policy. If
there is a lot of money going around, then supply is plentiful compared to the products
you can buy with that money. The law of supply and demand therefore dictates that prices
will rise.
• Increases in production costs.
• Tax rises.
• Declines in exchange rates.
 • Decreases in the availability of limited resources such as food or oil.
• War or other events causing instability.

Impact of Inflation

1. Inflation and Money

Inflation and money cannot be separate entities. Inflation is the increase in price levels, for a
certain period of time. Inflation affects the overall financial health of a nation. Inflation can also
be referred to, as the condition, when there is surplus of money as compared to goods as well as
services. In other words, money is in excess.

Inflation and its effects on money:

Inflation and its effects on money are plenty. Some of the important effects can be summarized
below: Store of value of money is affected. This occurs due to inflation, when the purchasing
power of money is impacted. This in turn diminishes money's role as store of value. Another
important effect of inflation on money is, that it becomes difficult to judge the performance of a
company. A slight increase in the percentage of inflation can make a marked difference in the
economy of any country and affect all the macroeconomic indicators of a nation. Inflation makes
the value of money weak. This is because with every passing day, the value of money
decreases(while inflation prevails). Since cost of all commodities escalate, the standard of living
of the common man gets affected. While the cost of goods increases, the salaries remain the
same. They do not increase. So, outgoing money exceeds the inflow to keep up with inflation.

2. Inflation and Unemployment

Inflation and unemployment go hand in hand. For every country, maintaining a low
unemployment rate is the main objective. It is usually believed that inflation and unemployment
are inversely proportional. There are many economists, who hold the opinion that low rate of
unemployment together with low inflation rate may be a source of concern. Both low inflation
rate and low unemployment rate, may be hypothetical. In real practice, this rarely happens. If a
particular country has full employment, it can be said to have minimum rate of unemployment. If
a nation maintains a minimum rate of unemployment in a condition when inflation rate is stable,
it is said to follow the natural rate of unemployment. In other words, the natural rate of
unemployment is the minimum rate of unemployment, which can be sustained.

Inflation and unemployment- how it works:

If rate of inflation increases suddenly, it temporarily reduces, the rate of increase in the wages.
Consequently, unemployment rate decreases. If the workers are able to cope with the increase in
inflation, unemployment rate is also less. However, when they do realize that in order to
compensate for the increase in price of commodities, the wages ought to be increased,
unemployment may rise to a considerable extent. This increase in the demand of wages, has a
tendency to reverse the unemployment curve to some extent (unemployment rises). If the rate of
inflation is very high, it does not mean that, there will be a permanent decrease in the rate of
unemployment. As a rule, rate of inflation and unemployment adjust themselves to attain the
equilibrium state, which is known as the natural rate of unemployment state, effortlessly. It just
happens.

3. Interest and Inflation

Interest and inflation are key to investing decisions, since they have a direct impact on the
investment yield. When prices rise, the same unit of a currency is able to buy less. A sustained
deterioration in the purchasing power of money is called inflation. Investors aim to preserve the
value of their money by opting for investments that generate yields higher than the rate of
inflation. In most developed economies, banks try to keep the interest rates on savings accounts
equal to the inflation rate. However, when the inflation rate rises, companies or governments
issuing debt instruments would need to lure investors with a higher interest rate.
The Relationship between Interest and Inflation

Inflation is an autonomous occurrence that is impacted by money supply in an economy. Central

governments use the interest rate to control money supply and, consequently, the inflation rate.
When interest rates are high, it becomes more expensive to borrow money and savings become
attractive. When interest rates are low, banks are able to lend more, resulting in an increased
supply of money.

Alteration in the rate of interest can be used to control inflation by controlling the supply of
money in the following ways:

• A high interest rate influences spending patterns and shifts consumers and businesses
from borrowing to saving mode. This influences money supply.
• A rise in interest rates boosts the return on savings in building societies and banks. Low
interest rates encourage investments in shares. Thus, the rate of interest can impact the
holding of particular assets.
• A rise in the interest rate in a particular country fuels the inflow of funds. Investors with
funds in other countries now see investment in this country as a more profitable option
than before.

4. Inflation and Exchange Rates

Inflation and its effects on exchange rates can also be ascertained from the following facts. In
earlier days, it was suggested by a majority of the economists to peg a particular currency or to
dollarize currency of a country. Nations (emerging countries) were used to having a fixed type of
exchange rate. Every effort was made to keep the exchange rate fixed because a floating
exchange rate was feared to cause inconvenience in trading.

Inflation and exchange rates- value of currency:

The exchange rates are essential macroeconomic variables. It affects inflation, trade (imports and
exports) and various other economic activities of a nation. If the rate of inflation remains low for
a considerable period of time, the value of currency rises. This occurs due to increase in the
purchasing power. Switzerland, Japan and Germany were three countries, the inflation rates of,
which were low during the late twentieth century. Other countries to follow suit were Canada and
United States of America. The countries, having higher rates of inflation observed depreciation
in their currency. On the other hand, countries with low rates of inflation did not observe this
trend at least for the time being. In the event when a nation is aware of a possible rise in inflation,
it can take measures accordingly. Exchange rates may also be affected by the type of inflation
prevailing in the economy. Inflation may be:

• Cost push inflation

• Demand pull inflation

5. Inflation and Monetary Policy

Inflation and monetary policy are closely related concepts wherein the latter can be used
efficiently to reduce the effect of the former. Inflation is thought of as the rise in prices and
wages that reduces the purchasing power of money. Monetary policy is the regulation adopted by
the central bank, currency board or other regulatory authority which stabilizes the prices and
maximizes production and employment of the country.

Relationship between Monetary policy and Inflation

The Fisher's equation depicts that proportional relation that exists between money supply and the
price level. Monetary policy is a regulation of a central bank or any regulatory authority, that
ascertains the size and growth rate of the money supply. Monetary policy directly influence the
interest rates which in turn has a negative relation with the price level. In the face of inflation the
central bank of the country generally resorts to a rise in the cash reserve ratio, repo rate and
reverse repo rate. So the basic idea is to reduce the money supply in the economy. To this end
government securities are also issued so as to mop up the excess money supply from the mass.
This would reduce aggregate demand. This reduction would again help reduce the price level.

Monetary policy is adopted with an objective to make the most of production and employment
and consequently stabilize the price level of a country. Monetary policy also regulates the
interest rate, availability of credit and at the same time promotes the overall economic growth of
a country. Monetary policy facilitates establishing trade relationships with other countries.

6. Inflation and Investment

Inflation, as we know reduces the purchasing power of individuals. Due to inflation, the cost of
goods increases and people have to spend more for buying a particular commodity for, which
they had to pay less earlier. Inflation inflicts injury to the common man, who live on limited
fixed income. Even if they have some savings, they are required to use the money to compensate
for inflation. Consequently, they are left with little money to fund for investments. The more an
individual routes the savings for investments, the greater are the chances for boosting growth in
the economy.

7. Inflation and Stock Market

Inflation is a state in the economy of a country, when there is a price rise of goods as well as
services. To meet the required price rise, individuals have to shell out more than is presumed.
Inflation and stock market have a very close association. If there is inflation, stock markets are
the worst affected.

Inflation and stock market- the logistics:

Prices of stocks are determined by the net earnings of a company. It depends on how much
profit, the company is likely to make in the long run or the near future. If it is reckoned that a
company is likely to do well in the years to come, the stock prices of the company will escalate.
On the other hand, if it is observed from trends that the company may not do well in the long run,
the stock prices will not be high. In other words, the price of stocks are directly proportional to
the performance of the company. In the event when inflation increases, the company earnings
(worth) will also subside. This will adversely affect the stock prices and eventually the returns.

Effect of inflation on stock market is also evident from the fact that it increases the rates if
interest. If the inflation rate is high, the interest rate is also high. In the wake of both (inflation
and interest rates) being high, the creditor will have a tendency to compensate for the rise in
interest rates. Therefore, the debtor has to avail of a loan at a higher rate. This plays a significant
role in prohibiting funds from being invested in stock markets.

When the government has enough fund to circulate in the market, the cost of goods, services
usually go up. This leads to the decrease in the purchasing power of individuals. The value of
money also decreases. In a nut shell, for the economy to flourish, inflation and stock market
ought to be more conforming and predictable.

8. Inflation and Economic Growth

Inflation is a condition, when cost of services coupled with goods rise and the entire economy
seems to go haywire. Inflation has never done good to the economy. However, whenever there is
expected inflation, governments around the world take appropriate steps to minimize the ill
effects of inflation to a certain extent. Inflation and economic growth are parallel lines and can
never meet. Inflation reduces the value of money and makes it difficult for the common people.
Inflation and economic growth are incompatible because the former affects all sectors as
indicated by:

• CPI or Consumer Price Index: A rise in the CPI indicates inflation. The CPI or the
consumer price index is used as an index for salaries, wages, contracted prices,
pensions. This is done to adjust with the inflation effects. It is an important economic
indicator.

• GDP or Gross Domestic Product: The gross domestic product is another important
economic indicator and is usually inflation adjusted. This is an important tool for
measuring the rate of inflation.
Recent inflationary trends

With 9% expansion in FY2007 India completed its fifth successive year of sturdy growth, even
against price escalation in almost all commodities and a backdrop of growing turmoil in
international financial markets. There was a remarkable increase in the performance of
agricultural production of 4.5% whereas industry and services growth were facing a downfall.

From the beginning of FY2008 the Indian economy faced a rise in the prices of vegetables,
pulses and other basic food stuffs. All this was accompanied with sharp rise in the prices when
the annual policy statement for 2008-09 was unveiled on April 29. Inflation increased steadily
during the year, reaching 8.75% by the end of May and in June when this figure jumped to 11%
then there was an alarming increase in the prices. There were many reasons for it but one of the
main driving forces was reduction in government fuel subsidies, which lifted gasoline prices by
an average 10%. Indeed, by July 2008, the key Indian Inflation Rate i.e. the Wholesale Price
Index touched the mark of 12.6%, highest rate in past 16 years of the Indian history. This was
almost three times the RBI’s target of 4.1% and almost doubled as compared to last year. This
continuous rise slipped back to 12.4% by mid-August.

Since the beginning of 2008 combination of various internal and external factors led to steep
domestic inflation and the resultant steps taken to control it in were slowing the pace of
expansion. These factors included the marked rise in the international prices of oil, food, and
metals, moderating the rate of capital inflows, worsening current and fiscal account deficits,
increasing cost of funds, minor depreciation of the Indian rupee against the dollar, and slow
growth in industrial economies. The Indian economy was at a critical juncture where policies to
contain inflation and ensure macroeconomic stabilization have taken center stage.

In the first quarter of FY2008 (i.e. April–June), growth rate of GDP slowed down to 7.9% from
9.2% in the corresponding prior-year quarter, for the slowest expansion in three and a half years.
The most remarkable decline was in industry where growth rate fell to 6.9% this was mainly
because of cutting in the manufacturing growth rate to 5.6%. The slowdown was widened when
agriculture and services sector showed a negligible growth of 1.4% and 0.9% points, below their
performances of the year-earlier quarter. Over the medium term, the main objective of the
government was to bring down inflation to 3%. The Repo and Reverse Repo Rates remained
unchanged whereas Cash Reserve Ratio (CRR) was increased by 0.25 percentage points. The
increased CRR that was effective from May 24 was 8.25%. Just days before the policy statement,
the CRR was again raised by 0.50 percentage point and over Rs. 27,000 crore of bank deposits
was impounded in three stages.

Consumption expenditure showed a steady growth in the first quarter of FY2008. Expansion in
fixed investment fell to 9.0% from 13.3% due to increasing interest rates and a weakening global
and domestic outlook appear to be causing companies to cut down their investment. Data
available for June confirms a general slowdown in the industrial production, which is most
noticeable in basic, intermediate, and production of capital goods. This indicates that investment
in the recent years has accounted for much of GDP growth; rising to about 34% of GDP in
FY2007—is slackening. Consumer durable goods production increased due to strong rural
demand whereas nondurable goods production contracted.

A survey of manufacturing companies was conducted by the Reserve Bank of India in June 2008
which indicated a moderation in business optimism. This was corroborated by the composite
business optimism index for July–September 2008 that was prepared by Dun and Bradstreet,
which shows a decline of 11.2% as compared to the previous quarter. In July, the BBB- rating on
foreign currency debt was confirmed but downgraded the view for India’s long-term local
currency debt from stable to negative, with a noticeable deterioration in the fiscal position.

Liquidity management became the primary objective for the central government. RBI did not
resort to increase the Repo Rate i.e. the rate at which it lends to the other banks against securities.
The reason behind this was that during times like this when the liquidity is high, banks will not
be borrowing from the RBI. Banks are supposed to decide on their interest rates when there is a
CRR hike and consequent monetary tightening. All this generally lead to increased interest rates
that are a desirable outcome in times of inflation.

Growth of the broad money supply (M3) had to be moderated in the range of 16.5 to 17 per cent.
While deposits were scheduled to rise by 17% and non-food credit disbursements by banks will
grow at a slow rate of 20% as compared to 22.5% in 2007-08. Credit disbursed by banks last year
was less as compared to the previous period. Bank credit had grown by a scorching 30% every
year for consecutively three years beginning in 2004-05.

Inflation based on the WPI gradually begun to rise from December 2007. It surged in the first 5
months of FY2008 to touch a 16-year high of 12.6% in early August but later on slipped back to
12.4% by mid-August. Hardening of prices of primary articles and manufactured products led to
a remarkable increase in the prices. Food inflation increased by about 2% points in the first half
of FY2008; thereby reaching a mark of 9.8% in mid-August.

Central government sought to limit price pressures by tightening monetary policy and adopting
various ad hoc interventions which includes reduction in customs duties on certain basic food
items, steel, crude oil, and oil products. Export of wheat, non-basmati rice, and pulses was
banned and export duties on some steel products were imposed.

RBI has altered key policy instruments to control inflation pressures in FY2008. These
alterations included raising the cash-reserve ratio several times and taking it to 9% by the end of
August and increasing the Repo Rate to 9% by July 29. Whereas the Reverse Repo Rate (the rate
at which banks park their surplus funds with RBI) remained unchanged i.e. 6%.

The prime lending rates maintained by the monetary policy were above 12% since January 2007
when inflation previously breached RBI’s tolerance level, even though inflation subsequently
subsided. By the end of August 2008, prime lending rates were in range of 12.75–
13.25%whereas the lending rates for nonprime borrowers were in the range of 15–17%. All this
could neither reduce credit expansion nor arrest the rise in prices. The root cause behind all this
was that the real interest rates have fallen.
Credit to the commercial sector by the banks has been rising in FY2008 with year-on-year
growth climbing to 26.8% by the end of July from 22.3% at end-March. The two main reasons
for the ongoing credit expansion were- a) High demand for working capital by the state owned
oil-marketing companies and b) bank loans to fill in for diminished foreign funding. Data on
foreign borrowings for FY2008 are not available; the cost of credit default swaps on prime
Indian companies is an indicator of risk aversion and tight access for maximum domestic
companies.

Fuel prices were artificially low due to a limited pass-through of international prices to the
domestic market. As a result it repressed inflation, fostered demand pressures and created off-
budget liabilities. Special bonds were issued to compensate state-owned oil-marketing companies
for selling less than their cost. This thereby resulted in “under recoveries” in FY2007 amounting
to Rs212.5 billion, or 0.5% of GDP. However these bonds could cover only a part of the loss
whereas the rest had to be absorbed by the companies. Domestic fuel prices were raised by about
10% when the average price of the Indian crude basket increased to $130 per barrel in June 2008.
This step was taken to limit the fast-growing losses. No compensation was provided to the
private oil-marketing companies for their losses stemming from price competition with the state
companies and thereby leading to some closures in their marketing operations.

The combined budget deficits of the central and state governments have been substantially
reduced over the past 5 years. This reflected sincere efforts by the government to adhere to fiscal
responsibility legislation. For FY2008, the central Government’s deficit is budgeted at 2.5% of
GDP and the states’ at 2.1% (4.6% of GDP on a consolidated basis). The major factors that
strengthen the appreciable fiscal consolidation from the base were a wider tax base supported by
a buoyant economy and improved compliance.

Two main situations that must be overcome before achieving the deficit targets for the FY2008
are: a slowing economy that may limit the revenue buoyancy seen in recent years and continuous
pressure by the Central Government to raise the salaries of its employees by 21% (about 0.3% of
GDP) in response to recommendations of the Sixth Central Pay Commission. Similar wage
increases were announced immediately by half a dozen states and others were following the suit.
On the other hand provision for these salary increases was not budgeted.

Expected magnitude of off-budget subsidy items is the major current fiscal issue which
undermines fiscal consolidation. The Economic Outlook prepared by the Economic Advisory
Council to the Prime Minister for the current year calculated three things-

1. That at a crude oil price of $130 per barrel, after considering the increase in price and
apportioning some contribution from oil production companies. The Government would
require issuing oil bonds to certain marketing companies of about Rs. 1.2 trillion or
equivalent to 2.2% of GDP.
2. That bonds amounting to 1.2% of GDP (Rs645 billion) need to be issued because at
prevailing import prices the budgeted fertilizer subsidy underestimated the cost.
3. Similarly calculation showed that the food subsidy requires a bond issue of 0.8% of
GDP.

The bonds issued for oil-marketing companies, fertilizers and food corporations of 4.2% of GDP
need to be sold so as to allow these companies to continue because their size is likely to create
monetary pressures. Private bank credit expansion in FY2007 was around 10% of GDP which
indicated problems for future. Thus, the addition to credit demand by issuing such large bond
resulted in steep rise in interest rates, crowd out investment, and piling up of inflation pressures.
All this continued unless the monetary policy was tightened sufficiently and the interest paid on
the bonds also led to fiscal pressures.

The trade and current account deficits have shown a tremendous increase in recent years, due to
escalating oil prices and the expansion in non-oil imports. This all was led by rapid growth in
consumer and investment demand. In FY2007, merchandise export growth was 23.7% whereas
the import growth was 29.9% and the resultant outcome was that the trade deficit widened to $90
billion (7.7% of GDP). The current account deficit was at $17.4 billion approximately 1.5% of
GDP, by the country’s healthy invisibles balance that stems mainly from exports by its
successful software and business services industry.

Exports expanded rapidly by 24.6% whereas imports expanded at 34.2%. Total oil imported
accounted for nearly 35% of total imports and increased by 54.9% to $35.0 billion. On the other
hand non-oil imports rose by 25.2% to $65.4 billion but at a slower pace as compared to FY2007.
This reflected decelerating economic activity in the first 4 months of FY2008.

Net foreign investment, including nearly $30 billion of portfolio investment as well as heavy
commercial borrowing by Indian companies led to capital account surplus of $108 billion in
FY2007. Foreign exchange reserves swelled to $300 billion at end-March 2008. Portfolio
investment recorded net outflows during April–July 2008 whereas direct investment increased.
Foreign exchange reserves have fallen by $13 billion in the first 5 months of FY2008 and as a
result the net capital inflows are on an appreciably lower level than last year. This drop in the
foreign reserves indicates that capital flows were insufficient to cover the current account deficit.
The accumulated reserves acted as a cushion against external vulnerabilities.

In the first quarter of FY2007 Indian Rupee appreciated against US Dollar, and then remained
stable for the rest of the fiscal year. Indian Rupee depreciated by 8.7% in the first half of
FY2008. By the end of August the exchange rate was Rs43.79/$1 and this clearly reflected the
toll of rising inflation, growing current account deficit and weakening capital inflows. Exporters
were being benefitted by the depreciation of the Indian Rupee. An outflow of funds from the
stock markets has been the key reason for the rupee erasing all its gains seen over the past five
years. In real effective exchange rate terms, rupee appreciation of 2007 had been offset by the
end of the first quarter of FY2008.

Commodity prices were rising but did not benefit the producers. The Government was facing a
difficult situation with some sections of the economy complaining of rising commodity prices
and leading to an inflationary situation. The terms of trade worsened for the farmers and they
received low prices for their products.
Central government along with RBI adopted various measures to control prices during the last
few months when the rising prices of necessary commodities became the topic of discussion
inside and outside the Parliament. The measures adopted were both direct and indirect in nature.
The indirect measures included resort to fiscal and monetary instruments.

In reality, if one person benefits, the other automatically looses. However, in this case no one
was getting the benefit and no one was suffering any loss. Solution to this problem lies in an
efficient marketing system.
Impact of Inflation in India

Inflationary pressures in any economy leads to depreciation of its domestic currency. This is
what our Indian economy was facing due to the running inflation and as a result Indian rupee
depreciated by about 20% since April 2008. Inflation affects-

1. Common man: Inflation effects a common man in different roles such –

a. As a consumer: Products such as crude oil, fertilizers, pharmaceutical products,

ores and metals, or use imported components such as Personal Computers and
laptops are directly imported. Due to depreciation of the Indian Rupee all these
goods became very expensive.

Components in computers such as processor, hard disk drive and motherboard are
also imported. Products such as mouse, keyboard and monitor also witnessed an
impact on their prices due to Rupee depreciation. Inflation may rise in an
economy when the input costs increase.

b. As a borrower: Companies or individuals, who have borrowed foreign currency

such as students with loans for studying abroad, need to pay more at the time of
repayment as the rupee depreciates. Many dollar-denominated loans resulted in
FOREX losses for companies with dollar loans, because of increased interest
payments and principal amount occasioned by the declining rupee.

For e.g. - if an individual borrows $100 when the exchange rate was Rs 45 for 1$,
his original borrowing is Rs 4,500. After the rupee depreciates and new exchange
rate is Rs 48 for 1$, then the same loan amounts to Rs 4,800. If the interest rate is
10 per cent, the additional interest turns out to be Rs 30 and an addition of 0.67
per dollar borrowed (30/45). Thus, the rupee depreciation results in an
incremental outflow of $7.34 (6.67+0.67) for this borrower.

In the case of loans taken via the Foreign Currency Non-Resident – Banks (FCNR
(B)) route, the borrower has to make sure that the overall cost of borrowing (cost
 of forward forex cover coupled with interest cost) in foreign currency is lower
than the rupee cost of funds.

c. As an investor: Depreciation of rupee makes imports of various components,

capital goods and raw materials more expensive. As inputs and other equipment
that are imported get costlier and reducing the profit margins. Companies that
import goods in bulk and those with heavy foreign currency borrowings may be
marked down in the stock market as the rupee depreciates.

d. As a Wage-earner: during inflation this class of common man suffered a lot

because of two reasons-

Increase in wages and salaries failed to keep pace with the rising prices.

ii) Wages increased during inflation but there is always a time lag between the
rise in price and increase in wages. As a result common man looses during the
intervening period.

2. Export companies: Due to depreciation of domestic currency exporters receive better

prices for their goods and services when sold in foreign markets.

3. Foreign Investors: Depreciation of Indian Rupee reduced the returns that foreign
investors used to earn by investing in Indian companies. Depreciation of a currency
triggered FII outflows. NRI investors, who previously invested their money in India
under various deposit schemes due to high interest rates, started finding those schemes
less attractive on account of rupee depreciation.

4. Country’s Balance of Payments: One of the drawbacks of depreciation of Rupee is that

exports become cheap in terms of foreign currency and imports become costlier. Current
account deficit widened because Indian imports basically constitutes essentials such as
crude oil, natural resources and many capital goods.
Depreciation of Indian Rupee made the exports more competitive globally and as a result
higher exports covered up the trade deficit.
5. IT companies: The IT sector is amongst the highest recruiters in the Indian economy and
a depreciating rupee spells good news for the sector. Bills for Information Technology
companies are basically prepared in dollars or in other foreign currencies. Depreciation of
the rupee increased their realizations and bodes well for their margins. The main reason
for the good performance in the second quarter of Infosys Technologies and Satyam
Computers was the depreciation of the Indian Rupee. An estimate suggests that a 1 per
cent depreciation in the rupee expands an IT company’s margins by 0.30-0.40 per cent.

6. Farmers: The prices of the primary commodities such as minerals, diesel oil and fuel,
power light and lubricants went up significantly. This disparity affected the agricultural
sector in two ways-

i) It had a restrictive effect on investments in farming and affected the production

efficiency.

ii) On one hand the agricultural commodity prices were falling or stagnant and on the
other hand increasing prices of agriculture inputs and other daily life commodities led
to deterioration in the living standard of the farmers.

Prices paid by the consumer have impacted by the cost of living of the entire value chain,
which grows on the inefficient markets and this adds to the final cost of the material. For
example, high energy cost itself has contributed to the increase in the cost of inputs
required for agriculture besides pushing up the marketing costs of farm products.
Conclusion

Majority of India’s population lies close to the poverty line and inflation acts as a ‘Poor Man’s
Tax’. More than half of the income of this group is spent on food and this effect is amplified
when food prices rise. The dramatic increase in inflation will have economic as well as political
implications for the Congress Government, with an election due within a year.

Economic growth rate in the emerging markets have slowed down but is far from over. The
BRIC countries i.e. Brazil, Russia, India and China alone account for more than 3 billion people
and with consumption rate increasing every year. It is expected that the high inflation rates will
be there for a long period of time which is worrying news for the Indian Government.

Direct regulatory measures such as the reduction in import tariffs were adopted in order relax the
supply-side pressures on various agricultural commodities. While adopting the direct measures,
the Government realized that the relaxation of supply-side pressures would dampen inflationary
expectations by increasing supplies in the commodities market.

However, these measures failed to have the expected impact due to the global market conditions.
Government reduced the Customs duty on various items and for some items making it zero. Due
to fundamental factors prices of various commodities increased and therefore the amount of
imports required now became costly. Indirect measures include the Fiscal Policy by the
Government and the Monetary Policy by the Reserve Bank of India to ensure that less money
chases fewer goods, thus reducing demand-pull inflation.

The RBI’s attempt to control excess liquidity in the market by raising the interest rates pushed up
real-estate prices as well as the commodity prices, thus fuelling inflation.

A closer look at certain commodities would reveal that the prices of sugar and wheat were
managed by the Government through various market intervention mechanisms. As a result the
physical market's role in effective price discovery was affected.

Trade in the commodities market operated in an asymmetrical information situation from both
the supply and demand sides. Hence, market operations could only benefit segments that were
privy to the available information. The existing agricultural market ecosystem revolves around
the traders and to some extent the producers with no say from side of consumers. Hence, at the
end both consumers and producers are often at a loss. Generally, traders keep a heavy margin to
compensate for the physical and financial risk involved in carrying the commodity for short as
well as long term.

Many small scale traders operate on a low scale and do not borrow. Therefore they undertake
small scale operations which require large number of intermediation before goods can move
from the farm gate to the consumer's plate, and they earn higher margins. The mark-up at each
stage pushes up the final price without benefiting the producers.

At the end I would like to conclude with what D.G Prasad said about inflation “The inflation
story is really a tale of what comes first, chicken or egg — that is, whether the inflationary
pressures are driving the commodity prices or the commodity prices are causing the current
inflationary trend”.