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What is Inflation.

Inflation is caused by money supply growing faster than the rate of economic growth . 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 average consumer.[

Inflation Vs Growth
Inflation is: the rate at which the general level of prices for goods & services soar. Each unit of currency buys fewer goods and services.

To control inflation, the central bank does tighten the monetary policy e.g. increase in the interest rate.
An increase in the interest rate has a side effect of curtailing the investment & employment leading to a slump in growth. India uses CPI (Consumer Price Index) for the calculation of Inflation rate.

Our View
An increase in economic growth must cause inflation to drop, and a reduction in growth must cause inflation to rise, in long run. Equation of exchange, MV = Py, where
M is the money supply; V is the velocity of money -- that is, the speed at which money circulates; P is the price level; and y is the real output of the economy (real GDP.)

An increase in the rate of economic growth means more goods for money to "chase," which puts downward pressure on the inflation rate.

Detail Explanation
Formula MV = PY Case 1 To lower food inflation RBI increases interest rates, as a result V(velocity) decreases, so P(price level) comes down a bit (in shirt term), but Y(real output) is also affected -- so we have bad long term effect

Case 2 To lower food inflation, government allowed supportive policies in agriculture, as a result Y increases and P goes down. MV remains constant.

Other explanation - Why does people believe Higher growth = Higher Inflation.
If the RBI increases the growth rate of the money supply, then sellers of products and sellers of labor will, for a while, see them as higher real prices and higher real wages. In response to this delusion, they supply more goods and more labour, increasing real GDP faster than otherwise. So we observe higher inflation and higher real GDP. But this is short term effect only.

Indias GDP and Inflation comparison


2007 2008 2009 2010 2011 Real GDP Growth (% growth) Inflation (% growth)

8.9 6.4

6.2

6.8

8.9

7.8

8.3 10.8 12.1 10.6

We see no relation between inflation and GDP growth, it seems logical when GDP growth decreases inflation goes up. But we also see when GDP decreases, inflation still goes up, it shows that our output is not increasing at the rate of our increase in demand. And RBI is pumping in more money, which makes items costlier.

Chinas GDP and Inflation comparison


2007 2008 2009 2010 2011 Real GDP Growth (% growth) Inflation (% growth) 14.2 9.6 9.2 10.3 9.5

6.3 -0.7

3.3

5.5

Again we see no relation between inflation and GDP growth, it seems logical when GDP growth decreases inflation goes up. But we also see when GDP decreases, inflation still goes up, it shows that our output is not increasing at the rate of our increase in demand. And Central China bank is pumping in more money, which makes items costlier.

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