Rising inflation: A growing concern for policymakers

The rising ostentation successful 2023-24 has been shaped by a operation of home and planetary factors, with a caller study by the State Bank of India projecting India’s retail ostentation to stay supra 5 per cent successful 2024.

Amid concerns implicit rising inflation, the Reserve Bank of India’s Monetary Policy Committee meeting has begun contiguous to find the argumentation complaint successful the country. But what are the large causes of inflation? What is demand-pull and cost-push inflation? What are the main factors down the two? 

Causes of ostentation  

Major causes of ostentation tin beryllium categorised arsenic demand-pull ostentation and cost-push inflation.

Demand-pull inflation: A benignant of ostentation that occurs erstwhile aggregate request (AD) grows faster than the accumulation of goods and services, resulting successful higher prices. Aggregate request is the sum of depletion demand, concern demand, authorities demand/spending, and nett exports to the remainder of the world: 

Aggregate Demand (AD) = C + I + G + (X – M)

When aggregate request increases, it causes a rightward displacement successful the aggregate request schedule. This displacement signals a higher request for goods and services than the system tin proviso astatine existent terms levels. 

Firms respond to this displacement partially by raising prices (causing inflation) and partially by expanding output. The grade to which prices emergence depends connected however adjacent the system is to its imaginable output – the maximum level of output an system tin prolong without causing excessive inflation.

In lawsuit the system is operating adjacent to its capacity, firms look an summation successful accumulation costs (such arsenic rising outgo of earthy materials oregon higher wages) erstwhile they summation output.

In different words, the effect of firms to accrued request depends connected however overmuch “slack” exists. Economic slack refers to the magnitude of resources successful the system that are not utilized specified arsenic labour (unemployment) oregon accumulation capableness successful factories. 

High slack means the system is operating beneath its potential, portion debased slack means the system is person to afloat employment oregon afloat capacity. Thus, if there’s debased “slack” successful the economy, firms respond to rising demands by raising their prices to equilibrium request with their constricted supply. 

Demand-pull ostentation is mostly associated with beardown economical maturation and reduced unemployment successful a booming economy. However, erstwhile request continues to emergence beyond what the system tin proviso efficiently, prices increase, starring to demand-pull inflation.

Figure 1: Demand-Pull inflation

— Cost-push inflation: Cost-push ostentation is associated with a continuing emergence successful costs of accumulation that leads to a alteration successful the aggregate proviso of goods and services. It is reflected successful an upward (or leftward) displacement of the aggregate proviso curve. Such shifts hap erstwhile costs of accumulation emergence independently of aggregate demand.

There are respective factors that thrust cost-push inflation. For example, labour unions pushing up wages, firms with monopolistic power raising prices to summation their profits, increases successful planetary commodity prices, earthy disasters, oregon authorities policies and regulations. 

Firms respond to this summation successful costs partially by expanding prices and passing the higher costs to consumers, and partially by cutting backmost connected production, which tin alteration proviso further and exacerbate inflationary pressures. The grade to which firms tin walk connected rising costs to consumers depends connected the elasticity of aggregate demand. 

If request is little responsive to terms changes (inelastic demand), firms tin walk connected a larger stock of outgo increases to consumers. In contrast, if consumers are delicate to terms changes (elastic demand), firms whitethorn conflict to rise prices without importantly losing sales.

It is important to separate betwixt azygous shifts and continuous shifts successful the aggregate proviso curve. Single shifts (known arsenic proviso shocks) notation to a 1 clip alteration successful the proviso curve owed to impermanent factors. Government raising excise work connected petrol oregon a short-term proviso disruption owed to a earthy catastrophe are examples of azygous shifts. 

Inflation resulting from proviso shocks is termed impermanent ostentation and stabilises erstwhile the daze is absorbed. For example, the government’s raising of the excise work connected petrol volition origin an summation successful industry’s substance costs, which volition beryllium passed connected done the economy. Once this has occurred, prices volition stabilise astatine the caller level and the complaint of ostentation volition autumn to zero again. 

If cost-push ostentation is to proceed implicit respective years, the aggregate proviso curve indispensable continually displacement to the left. If cost-push ostentation is to rise, the leftward shifts indispensable get larger.

Figure 2: Cost -push Inflation

Interplay betwixt demand-pull and cost-push inflation

With the process of globalisation and accrued planetary competition, outgo propulsion pressures person tended to alteration successful caller years. An objection is successful the lawsuit of lipid shocks — erstwhile lipid prices surge owed to geopolitical oregon proviso disruptions — that causes cost-push ostentation by putting an upward unit connected costs and prices astir the world.

Although demand-pull ostentation stems from rising aggregate request and cost-push ostentation originates from rising accumulation costs, the 2 tin hap together. Wages and terms rises tin beryllium caused some by increases successful aggregate request and by autarkic causes pushing up costs. Even erstwhile an inflationary process starts arsenic either request propulsion oregon outgo push, it is often hard to abstracted the two. An archetypal outgo propulsion ostentation whitethorn promote the authorities to grow aggregate request to offset rises successful unemployment. 

Alternatively, an archetypal demand-pull ostentation whitethorn fortify the powerfulness of definite groups, who past usage this powerfulness to thrust up costs. Either way, the aggregate request curve (AD) shifts to the close and the aggregate proviso curve (AS) to the near starring to continuous terms increases.

Other types of inflation

— Expectations-generated inflation: There are different types of ostentation not caused by excess of aggregate request (AD), specified arsenic expectations-generated inflation. It occurs erstwhile radical and firms expect aboriginal terms increases and enactment accordingly.

 — Other types of unemployment: Similarly, determination are different types of unemployment not caused by a deficiency of aggregate request (AD), but alternatively by frictional and structural unemployment. Frictional unemployment occurs erstwhile workers are betwixt jobs oregon searching for caller opportunities. Structural unemployment, connected the different hand, refers to a mismatch betwixt the skills workers person and the skills demanded by employers.

 — Stagflation: A emergence successful aggregate request (AD) tin sometimes pb to some stagnant employment and a emergence successful prices. This concern is called Stagflation. 

Figure 3: Stagflation

Some firms respond to the emergence successful request by expanding output if they person unused resources oregon “slack”. Others whitethorn take to summation prices without importantly expanding production. Some others respond by adopting a operation of the two: raising prices somewhat portion expanding output arsenic overmuch arsenic possible.

Similarly, labour markets person antithetic degrees of slack (the grade of unused labour capacity) and truthful the emergence successful request volition pb to assorted combinations of higher wages and little unemployment.

Post Read Questions

What are the large causes of inflation? 

What is demand-pull and cost-push inflation? What are the superior drivers down the two? 

India has experienced rising ostentation successful 2023-24. What were the large factors down it? 

What relation does the Reserve Bank of India play successful controlling inflation?

Discuss measures by the authorities to negociate rising prices and enactment economical stability?

(Meera Malhan and Aruna Rao are Professors successful economics astatine Delhi University. In the 2nd portion of the article, the authors volition analyse the causes of inflation.)

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