Q. With reference to the Indian economy, demand-pull inflation can be caused/increased by which of the following?

1. Expansionary policies
2. Fiscal stimulus
3. Inflation-indexing wages
4. Higher purchasing power
5. Rising interest rates

Select the correct answer using the code given below.

• 1, 2 and 4 only
• 3, 4 and 5 only
• 1, 2, 3 and 5 only
• 1, 2, 3, 4 and 5

Answer: a) 1, 2 and 4 only

Inflation

• Inflation is a rise in prices, which can be translated as the decline of purchasing power over time. The rate at which purchasing power drops can be reflected in the average price increase of a basket of selected goods and services over some time.
• It reflects the rising cost of living and indicates how much more expensive a set of goods and/or services has become over a specified period, usually a year.
  • In India, inflation’s impact is particularly significant due to economic disparities and a large population.
• Different Causes of Inflation:
  • Demand-Pull Inflation:
    • Demand Pull inflation occurs when the demand for goods and services exceeds their supply. When the overall demand in the economy is high, consumers are willing to pay more for the available goods and services, leading to a general rise in prices.
    • A booming economy with high consumer spending can create excess demand, putting upward pressure on prices.
      • Cause for Demand-pull inflation are:
        • Increasing government expenditure
        • Increasing money supply (liberal monetary/fiscal policy)
        • Parallel economy/black money
        • Increasing forex reserves (As foreign currency reserves rise demand for rupee goes up and that creates inflation.)
        • Rising population
        • Rise in income and wages
        • Climatic changes
        • Specific consumer preferences
      • Expansionary policies: When the government spends more freely, money in the market is increased. It leads to increase demand for the goods and fuels demand-pull inflation.
      • Fiscal Stimulus: It also increases the money in the market leads to increase demand for the goods and fuels demand-pull inflation
      • Higher Purchasing Power: When consumers earn higher income, they feel confident and spend more. This leads to more demand and fuels Demand-pull inflation
        • The rising interest rate – It decreases the money supply in the economy. This may result in a credit crunch in the economy. It is costlier to borrow money in the economy and it leads to a decreased money supply. So, it can not cause demand-pull inflation in the economy.
        • Inflation-indexing wages – Inflation indexing wages, wages in the economy is linked to inflation which means wage moves as inflation changes in the economy. Such indexing is provided to reduce the effect of inflation on wages. For example – a worker is getting 100 rs as a wage and inflation in the economy increases to 5%, so the wage of the worker increases by 5% i.e. 105. So effective change in the wages is zero and it does not increase/decrease purchasing power. So, it can not lead to a demand to pull inflation in the economy.
  • Cost-Push Inflation:
    • Cost-push inflation is driven by an increase in the production costs for goods and services. This can be caused by factors such as increased incomes, increased costs of raw materials, or disruptions in the supply chain.
    • Causes for Cost-push inflation are:
      • Infrastructural surcharges
      • Increase in indirect taxes
      • Increase in prices of raw materials
      • Supply shocks
      • Rise in administered prices
      • Rise in imported inputs
  • Built-In or Wage-Price Inflation:
    • This type of inflation is often described as a feedbackloop between wages and prices. When workers demand higher wages, businesses may raise prices to cover the increased labor costs. This, in turn, prompts workers to seek higher wages, and the cycle continues.
      • Collective bargaining by labor unions can result in higher wages, leading to increased production costs and subsequently higher prices for goods and services.