Assignment 1: Inflation rate in India touched 12% in July 2008. What was the dilemma faced by the RBI & the government in adopting strong measures for controlling inflation. Explain in detail.
INTRODUCTION :
In economics, inflation is a rise in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer good and services. Consequently, inflation also reflects an erosion in the purchasing power of money - a loss of real value in internal medium of exchange and unit of account within the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the consumer price index) over time.
Inflation reflects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation is rapid enough, shortages of goods as consumers being hoarding out of concern that prices will increase in the future. Positive effects include ensuring that central banks can adjust real interest rates (intended to migrate recessions), and encouraging investment in non-monetary capital projects.
Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.
IS INFLATION RISING OR FALLING ?
Monthly inflation for January was fairly significant at 0.30% or an annualized 3.6% but was significantly lower than last January which was 0.44% so the annual inflation rate decreased.
This is a big change from December which was negative (deflationary) at -0.27% so January and December basically cancelled each other out. You can see this in that the CPI index in November was 230.221 and in January it was 230.280. since October and November were also negative the price index is at about the same level as it was in April and August 2013. (230.085 and 230.379 respectively)
Annual Inflation
INFLATION RATE IN INDI9A IN JULY 2008 :
Economists' interest on how to construct the appropriate aggregate price index and measures the inflation rate has the history of a centaury long period. Over this period, paradigm shifts are evident from the literature moving across the spectrum of views. The early literature shows that Irving Fisher (1906) was in favour of a board transaction price metric or the aggregate price index, comprising prices of goods, services and assets in order to reflect on the price level as implied by the broader equation of exchange and guide the authorities in determining the price of monetary unit. However, Fisher maintained that the appropriateness of any price index could be contextual; different problems necessitating different indices due to differences in the comparative places or comparative times under investigation (Bryan, et.al. 2002). Deriving from Fisher (1906) and samuelson (1961). Alchian and Klein (1973) and Shubiya (1992) worked on the dynamic price index consistent with inter-temporal consumption optimization by the households. The dynamic price index did not receive general support due to various practical problems (goodhart and Hofmann, 2000, Shiratsuka, 1999). During the 1980s and the 1990s, economists developed two variants of the core inflation indicator; one was consistent with the long-run supply curve (Eckstein, 1981) and the other better connected with monetary aggregates (Bryan and Cecchetti, 1993, 19994). The threshold inflation rate, owning to Tobin (1965), came into prominence with the works of Barro (1992), Sarel (1999) and Clark (1995). Some economist brought the concept of 'hedonic prices' (Rosen, 1974, Shiratsuka, 1995). In the wake of low commodity price inflation condition and the surge in asser prices supported by technology stocks and the housing market during the second half on the 1990s through the first half of the current decade, economist again turned skeptical about the exisiting aggregate price indices with the argument that these indicators did not include services and assets. Thus, the large literature evolved on asset prices and their implications for policy (Saxton, 2003, Roubini, 2006).
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How Government and Federal Reserve Bank of India (RBI) causes Inflation:
Here are the reports on how and when Government and RBI infused currency in the market:
First Stimulus Package: Indian Newspaper the Hindu reported that the economic stimulus has been offered to various economic sectors of Indian economy to help them against the global downturn. The housing and infrastructure sector, automobile companies, textiles, cement and other sectors were provided an additional Rs 20,000 crore.
Second Stimulus Package: Government announced Rs32,000 stimulus package to boost Indian economy. Montek Singh Ahluwalia, then Deputy Chairman of planning Commission announced a stimulus package of over Rs 20,000 crore for the "Round II Package" that was meant to reduce stress on financial companies, real estate, infrastructure and small and medium business.
Third Stimulus Package: In order to offer a boost again, Indian government announced a new stimulus and offered a two percent cut in excise duty and service tax, that is, government offered free floating fiat currency of measure around RS 30,000 crore in market. This cut was above the four percent cut in CENVAT announced in December 2008, which was extended to beyond March 31.
Changing International and Emerging Market Perspectives
2.4 There is some literature which supports a free capital account in the Context of global integration, both in trade and finance, for enhancing and welfare. The perspective on CAC has, however, undergone some change
Following the experiences of emerging market economics (EMEs) in Asia and
Latin America which went through currency and banking crises in the 1990s.
A few countries backtracked and re-imposed some capital control as part of Crisis resolution. While there are economic, social and human costs of crisis, it has also been argued that extensive presence of capital controls, when an economy opens up the current account, creates distortions, making them either ineffective or unsustainable. The costs and benefits or risks and gains from capital account liberalization or controls are still being debated among both academics and policy markers. The IMF, which had mooted the idea of changing its Charter to include capital account liberalization in its mandate, shelved this proposal.
2.5 These developments have led to considerable caution being exercised by
EMEs in opening up the capital account. The link between capital account liberalization and growth is yet to be firmly established by empirical research.
Nevertheless, the mainstream view holds that capital account liberalization can be beneficial when countries move in tandem with a strong macroeconomic policy framework, sound financial system and markets, supported by prudential regulatory and supervisory policies.
Obejectives and significance of Fuller Capital Account Covertibility (FCAC) in the Indian Context 2.6 Following a gradualist approach, the 1997 Committee recommended set of measures and their phasing and sequencing. India has cautiously opened up its capital account since the early 1990s and the state of capital controls in India today can be considered as the most liberalized it has ever been in its history since the late 1950s. Nevertheless, several capital controls continue to persist.
In this context, FCAC would signify the additional measures which could be taken in furtherance of CAC and in that sense, 'Fuller Capital Account Convertibility' would not necessarily mean zero capital regulation. In this context, the analogy to de jure current account convertibility is pertinent. De jure current account convertibility recognizes that there would be reasonable limits for certain transactions, with 'reasonable' being perceived by the user.
2.7 FCAC is not an end in itself, but should treated only as a means to realize the potential of the economy to the maximum possible extend at the least cost. Given the huge investment needs of the country and the domestic savings alone will not be adequate to meet this aim, inflows of foreign capital become imperative.
2.8 The inflow of foreign equity capital can be in the form of portfolio flows or foreign direct investment (FDI). FDI tends to be also associated with nonfinancial aspects, such as transfer of technology, infusion of managements and supply chain practices, etc. In that sense it has greater impact on growth. To what extend HDI is attracted is also determined by complementary policies and environment. For example, China has had remarkable success attracting large FDI because of enabling policies like no sectoral limits, decentralized decision making at the levels of provisional and local governments and flexible labour laws in special economic zone. By contrast in India, policies for portfolio or Foreign institutional investor (FII) flows are much more liberal, but the same cannot be said for FDI. Attracting foreign capital inflows also depend on the transparency and freedom for exit of non-resident inflows and easing of capital controls on outflows by residents. The objectives of FCAC in this context are :
(i) to facilitate economic growth through higher investment by minimizing the cost of both equity and debt capital;
(ii) to improve the efficiency of the financial sector through greater competition, thereby minimizing intermediation costs and
(iii) to provide opportunities for diversification of investments by residents.
