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Causes and Impact of Inflation

Causes and Impact of Inflation


  • Inflation in theory occurs when the quantity of money in the economy grows at a higher rate than the GDP in real terms. However, this is only part of the reason for the inflationary pressures in the Indian economy.
  • Inflation can be demand-pull as well as cost-push. The demand-pull factors are, briefly: increase in government expenditure under developmental and non-plan heads and the existence of a parallel economy.
  • Total public expenditure (centre and states together) has risen from Rs. 740 crore in 1950-51 to Rs. 3,81,200 crore in 1997-98.
  • While developmental expenditure leads to creation of assets, it is non-plan expenditure such as on salaries and allowances of employees and subsidies to loss-making public sector units that creates idle demand without any corresponding supply.                                            Causes and Impact of Inflation


Economists point out that subsidies constitute a major burden on the national budget. There are inevitable leakages in subsidies and much of it does not reach the intended beneficiaries.

In many cases, the benefits are cornered by the undeserving. Most of our agricultural and food subsidies suffer leakages in subsidies. In order to assist proper targeting of subsidies, goods are classified into three categories:

  • Public goods National defense, police, general administration etc. These services are available to all and the enjoyment by one is not at the expense of another. Nor can a price be put on these services.
  • Merit goods Primary education, immunization, public health programme etc. Not only individual beneficiary but society at large benefits by making these goods available. Thus, merit goods contain ‘externalities’. There is justification for providing subsidy to these goods.
  • Non-merit goods Sometimes referred to as Public ‘bads’ (as opposed to ‘goods’) here the benefit goes directly to the individual while the costs are borne by the society. Pollution caused by automobile emission is an example of non-merit goods.                                                            Causes and Impact of Inflation


  • It has been said that inflation is the most regressive form of taxation as it affects the poor and the vulnerable sections of the society the most. In the Indian context, it is the unorganized, without the benefit of trade union or political patronage, who suffers the worst effects of inflation.
  • Such a situation leads to increasing income disparities. Inflation dampens exports by making our products expensive and, conversely, makes imports attractive. Such a situation may warrant formal or informal devaluation of the currency in order to make our exports competitive.                                        Causes and Impact of Inflation
  • Inflation leads to recession, as people with fixed incomes set apart an increasing share of their income to meet the growing costs of essential commodities, leaving very little for expenditure on non-essential terms. The production of such items has to be curtailed, leading to shutdowns and recession.
  • Finally and most importantly, high and persistent inflation affect economic growth adversely by dampening the investment climate and by raising further inflation-expectation.
  • Any measure taken to rein in inflation may also sometimes affect growth, but policy makers have to decide on a trade-off between growth and inflation control.


Indian Economy

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