Inflation

Inflation refers to a sustained rise in the general price level in the economy and a fall in the purchasing power of money over some time. It primarily occurs due to two sets of factors, the demand-pull factors, and the cost-push factors. Demand-pull inflation arises when aggregate demand in the economy becomes more than aggregate supply. It occurs due to the following factors:

• Increase in government expenditure: Increased government expenditure, for example, Direct Benefit Transfers, increases the purchasing power, leading to increased demand at constant supply, resulting in price rise.
• Increased income: Rise in purchasing power due to higher disposable income in the hands of people; for example, the implementation of the 7th Pay Commission, leads to an increase in demand for commodities/services, which in turn leads to inflation.
• Changing consumption patterns: An increase in consumption, for example, of protein-rich food like pulses, eggs, fish, etc., can increase the prices of these commodities in the economy.
• Rapid rise in population: In the case of India, increased demand due to the rising population results in a demand-supply mismatch, raising the prices.
• Black money: It increases the demand for commodities, leading to extensive hoarding and black marketing of essential goods. For example, a large part of the black money is used in buying and selling real estate in urban areas, thus fuelling demand and leading to rising real estate prices.

Cost-push inflation arises when the aggregate supply of goods and services decreases because of an increase in production costs. It occurs due to the following factors: Demand and supply mismatch: When aggregate supply does not meet the aggregate demand e.g., a rise in oil price due to situations like the Russia-Ukraine crisis leads to inflation. An increase in the cost of wages and raw materials also leads to cost-push inflation.

• Infrastructural bottlenecks: Infrastructural issues, for instance, the lack of proper roads increased the logistic costs, poor supply of electricity incurs additional costs due to the provision of alternate measures, etc. All these, ultimately lead to a rise in the cost of production.
• Seasonal and cyclical fluctuations: Owing to events such as failed monsoons there is a drop in agricultural productivity, which inevitably results in inflation at times.
• Increase in taxation: These taxes add up to the retail prices of the commodity. For example, taxes such as customs and excise duty levied on commodities raise the cost of the commodity.
• Increase in administered prices: When the government increases the MSP (Minimum Support Price) for food grains, taxes on petroleum products, etc., it leads to inflation.

To control inflation and maintain price stability in the economy, the government has formed an institutional Monetary Policy Committee. Further, the fiscal policy of the government works in tandem with the inflation target determined by the Monetary Policy Committee.