• Typically, inflation in India is primarily influenced by factors related to supply but there are times when demand factors also play a significant role, according to an article published by the Reserve Bank of India as a part of their December bulletin.

Inflation

• Inflation, as defined by the International Monetary Fund, is the rate of increase in prices over a given period, encompassing a broad measure of overall price increases or for specific goods and services.
• 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.

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.
• 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.
• For instance, (as per CPI data) inflation in ‘oils and fats’ in March, 2022 soared to 18.79% as the geopolitical crisis due to the Russia-Ukraine war pushed edible oil prices higher.
• Built-In or Wage-Price Inflation:
• This type of inflation is often described as a feedback loop 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.
• Monetary Inflation:
• Monetary inflation is often linked to an increase in the money supply in an economy. When there is more money in circulation, consumers have more purchasing power, which can drive up demand and prices.
• Central banks printing more money or implementing policies that increase the money supply can contribute to monetary inflation.
• Supply Shocks:
• Supply shocks occur when there is a sudden and unexpected disruption to the supply of goods and services. Natural disasters, geopolitical events, or other unforeseen circumstances can lead to a reduction in supply, causing prices to rise.
• A drought affecting agricultural output can lead to a decrease in the supply of crops, causing food prices to spike.
• Built-In Expectations:
• If people expect prices to rise in the future, they may adjust their behavior accordingly. This can create a self-fulfilling prophecy where businesses raise prices in anticipation of higher costs, and consumers, expecting further increases, may buy more now, contributing to inflation.
• If individuals believe that inflation will increase in the future, they may demand higher wages and businesses may raise prices in anticipation of increased costs.

Impacts of Rising Inflation

• Inflation erodes the purchasing power of money, meaning that with the same amount of money, individuals can buy fewer goods and services.
• Central banks often respond to inflation by raising interest rates. Higher interest rates can increase the cost of borrowing for businesses and individuals, potentially slowing down investment and economic growth.
• High or unpredictable inflation can create uncertainty in the economy. Businesses may find it challenging to plan for the future when prices are constantly changing.
• Persistent and high inflation can have social and political consequences. It may lead to public dissatisfaction, protests, and demands for wage increases.

Types of inflation include:

• Deflation: Deflation is the opposite of inflation and refers to a sustained decrease in the general price level of goods and services. It occurs when the supply of goods exceeds demand, leading to reduced prices. Deflation can discourage spending, as consumers may delay purchases in anticipation of lower prices, which can further slowdown economic growth and potentially lead to recession.
• Hyperinflation: Hyperinflation is an extremely high and typically accelerating inflation. It occurs when the price levels rise rapidly, eroding the value of the currency. This phenomenon often results from a collapse in the currency and is detrimental to the economy, leading to a loss of confidence in the currency and undermining economic stability.
• Stagflation: Stagflation is a situation characterized by a combination of stagnant economic growth, high unemployment, and high inflation. It presents a challenge for policymakers, as traditional measures to stimulate economic growth, such as increasing the money supply, may exacerbate inflation.
• Reflation: Reflation is an attempt to stimulate an economy that is experiencing deflation. It involves the implementation of monetary or fiscal policies to increase the money supply and boost aggregate demand, with the aim of reversing deflation and stabilizing prices.

RBI’s December 2023 Bulletin: State of the Economy

• Global Economic Outlook:
  • Inflation Impact:A slowing rate of global inflation may contribute to a reduction in global interest rates in the future.
• Interest Rate Reductions:
  • Potential Scenario:Disinflation in different geographies may pave the way for interest rate reductions globally.
  • Expectations:Central bank officials anticipate a possibility of reduced global interest rates in response to economic conditions.
• Indian Economic Scenario:
  • Economic Activity:India is experiencing a broad-based strengthening of economic activity.
  • Factors Supporting Growth:Easing input costs and corporate profitabilityare expected to sustain economic activity in India.
• CPI Inflation in India:
  • Recent Trends:Consumer Price Index (CPI) inflation in India rose to 5.6% in November.
  • Projection:Officials anticipate CPI inflation to ease to an average of 4.6% in the first three quarters of 2024-25.
• Domestic Financial Markets:
  • Market Performance:Domestic financial markets have been positively influenced by the enduring strength of the real economy.
• Indian Economic Growth in 2023:
  • Optimistic Outlook:Despite significant global challenges, the Indian economy remained the fastest-growing major economy in 2023.
  • Consumer Confidence:Cautious optimism prevails as consumer confidence remains positive, and perceptions about current income improved.
• Supply Chain Pressures and GDP Growth:
  • GDP Growth Forecast:The Reserve Bank of India’s Economic Activity Index forecasts GDP growth for Q3 2023-24 at 6.7%.
• Outlook for H2 2023-24 and 2024-25:
  • Sustained Growth:Despite some moderation, growth is expected to be sustained in the second half of 2023-24 and in 2024-25.
  • Positive Indicators:Positive consumer confidence and favorable perceptions about current income contribute to the outlook.