Inflation can be broadly defined as the rise in price level. Inflation is measured by the movement of price indices. A sustained downward sufficiently long pressure on prices is expected to inevitably bring inflation to an end. ( Kaldor, 1986). Some countries use Consumer Price Index (CPI) as the measure for inflation, whereas some other countries use Wholesale Price Index (WPI). Inflation reduces the purchasing power of people; as a result the prices will go up. The industries may demand for more funds for carrying on the production. Consequently, the demand for funds will go up resulting into the interest rates going up. The opposite of inflation is deflation which occurs when the prices are falling. Inflation will cause unemployment and a rising inflation coupled with a rising unemployment is known as stagflation. USA was facing the problem of stagflation in 1970s (Siglitz & Walsh, 2002). In short, the rate of inflation is the rate of change of the general price level (Samuelson & Nordhas, 2001).
Factors Responsible for Inflation
Inflation can go up or down or even remain at the same rate. Inflation can persist at the same rate for a while and a shock to the economy can push the inflation up or down (Samuelson & Nordhas, 2001). Economists have classified the factors contributing inflation under two major heads. These are Demand Pull Inflation and Cost Pull Inflation.
Demand Pull Inflation: When the aggregate demand overtakes the aggregate output the prices tend to increase leading to inflation. This happens because the fall in the output will weaken the supply side because of which the buyers will be ready to pay any price leading to spiraling prices. For example when the agricultural production comes down the supply of food grains, pulses etc. also come down leading to an increase in the prices of these commodities. The demand pull phenomenon happens when the aggregate money supply in the country goes up which provides enormous money with the people who will be ready to pay what ever the price is asked. The situation leads to the increase in the price. The increase in money supply can happen either at the governmental initiative or industry initiative. The government at times resorts to deficit financing by pumping additional money into economic system by printing currency notes. Since the additional money is not coming from generic sources it can cause price rise. Another factor causing an increase in the money supply is the international capital flows. Unchecked foreign exchange inflows though burgeons the foreign exchange reserve and provides buoyancy, the conversion of these inflows into domestic currency can increase the money supply leading to inflation. In order to insulate the economy from inflationary pressures, countries sterilize these inflows. We have live examples of Latin American and East Asian Currency Crisis when the inflation rates in the affected countries shot up to double digit figures. The demand-pull can also occur on account of wages which increases the supply of money in the hand of people who will be ready to buy goods and services at what ever price they are offered. Consequently the prices of commodities go up causing inflation. Increase in government spending also pushes more money to the market leading to increase in prices.
Cost –Push Inflation: The second factor is the effect of cost. Inflation resulting from rising costs during the periods of high unemployment and slack resource utilization is called the cost-push inflation. For example, during the early 1990s when the Indian economy was opened up, the domestic firms went abroad and borrowed heavily through the External Commercial Borrowing (ECB) route. Consequently, the industry experienced large scale surplus resources, which they invested in the real estate resulting into the real estate in the metros like Mumbai, Delhi etc. shooting up. The cost can also go up when the bargaining power of employees increases and they demand more wages. The manufacturers will load the increase in their cost due to the hike in wages in the products leading to rise in prices. Similarly when the local currency weakens and foreign currency appreciates, the import becomes dearer leading to increase in the cost of inputs which will lead to the increase in prices. On the other hand the increase in the exchange rate will enable the exporters to earn more than their actual investment creating additional money supply in the country again leading to inflationary pressures. Some economists argue that increase is in money supply is the result and not the cause of inflation ( Jennie Hawthorne, 1983).
Another reason is the cost of funds. The interest and inflation rates are directly connected. As inflation rate goes up interest rate also goes up because of the higher price level leads to higher spending necessitating more funds, thereby pushing up the borrowing cost. Another effect of interest is that an upward movement of interest rate will attract more international investments and the consequential capital flow will lead to more money with the people. Unless these inflows are sterilized effectively, the country can be pushed to the grip of inflation.
Management Perspectives of Inflation
The inflation can pose problems for managers from two angles. One is the supply side and the other is the cost side. The inflation increases the prices of raw materials and consequently the managers may be compelled to increase the prices of their products and services. The increase in the price level will push up the cost of production from two angles. One is the raw material prices as explained above and the other is the cost of labour. The employees will demand more wages to meet the increased price level which will push up the labour cost. In fact it becomes a vicious circle as far as a manager is concerned because the increase in wages will push the price of the final output which will lead to demand for further in crease in the wages. From the supply side also this happens because an increase in price will reduce the supply side leading to further reduction in the supply because being unable to bear the increased cost of production, manufacturers may bring down their production. Generally, a conventional profitability statement carries some figures relating to cost such as depreciation charges and cost of goods sold or consumed previous years also. These factors can produce significant errors in profit measurement during a period of inflation (Kirkman, 1978). Therefore, the inflationary pressure often leaves the managers into a dilemma as to whether to increase the cost of their products or to absorb the cost and bear the losses which will eat away their bottomlines. As the managers are accountable to the shareholders, they will often avoid this route. On the other hand managers may be facing the pressure from the government to reduce the cost to contain the inflation. The government may institute several measures like withdrawing the excess liquidity in the market through the Central Bank interventions. Government also may impose levy and quota restrictions in order to curtail the price rise of essential commodities. Managers may also have to face the threat of strike from trade unions if they attempt to wage-cut or refuse to meet their demand for increasing the wages. As a student of management, these situations give me many lessons to learn, particularly the impact of inflation on the economy as well as on the firms.
Inflation in India
The data on inflation in India during the last 5 years covering the period from 1st April 2003 to March 31, 2008 shows cyclical variations in the inflationary pressures. Data collected relates to monthly closing inflation from which quarterly and half yearly averages where computed to study the seasonal and cyclical variations. The following diagrams show the monthly, quarterly and half-yearly variations of the inflation.
Monthly Variations
The chart shows periodical rise and fall in the inflation. The inflation registered 6.7 % in April 2003, but declined to a level of 3.88% by August 2003. During the period September 2003 to February 2004, it was hovering around 5% and then started increasing to reach a peak level of 8.74% in August 2004. The inflation again came down to reach 3.33 % in August 2005 and varied between 4% and 6 % till it registered 6.69% in January 2007. The last figure 6.68% as on 31.03.2008 is very close to that in January 2007. The latest figure shows that the inflation crossed 7 percent and reached 7.33%.
Quarterly Variations
The quarterly average inflation during the period April 2003 to March 2008 varied between 5% and 5% and 6.5% except the peak level of 8.03 in September 2004. Thereafter, the inflation started declining and reached as low as 3.61% in December 2007 and then climbed up to reach 5.3% in March 2008
Impact of Seasonal Variations
In order to check the impact of seasonal variation, a chart was created using the half yearly averages from April 2003 to March 2008. The diagram below shows the half yearly average inflation. In India we have a busy season commencing from October and ending in March and a slack season from April to September. The chart also was constructed using the corresponding data. Reserve Bank of India announces their Annual Policy in April and Mid Term Review in October every year. These policy documents contain measures for arresting inflation. The chart shows that the inflation rates were coming down or going up after the policy announcements indicating some impact on the policy measures on the inflationary trends. During the one year period from April 2003 to March 2004, the inflation came down by more than 1 percent and reached a higher level of 6.9 per cent. Thereafter it gradually declined to reach a lower level of 4.3 per cent and climbed to 5.9 per cent. Towards the last leg the average inflation came down to 4.6 per cent.
Economists are of the view that the inflation in India has primarily emanated from the supply side and mostly from the pressure exerted by the primary articles. The movement of international price of Crude Oil also contributes in pushing up the inflation. A section of the economists are skeptical about the validity of our price indices because of the base year which is 1993-94, the share of different goods in the basket and the time taken to announce the price movements. Another view is that service sector being one of the emerging consumption segments does not have the deserving share in the basket. Alternatively it can be assumed that the inflation in India is more controlled by the prices of Onions and Potatoes and therefore the monsoon and cropping pattern greatly affect the movement of the price indices.
Conclusion
Inflation indicates the changes in price indices at two different point of time. In India inflation is measured by the movement of Wholesale Price Index. Inflation can be demand-pull inflation or cost-push inflation. Our inflation is more or less demand-pull because the supply side play great role in the movement of prices. The inflation affects the industries because of its impact on the cost of production. Hence managers should be concerned about the inflation and do suitable adjustments to contain the inflation.
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