Friday, October 31, 2008

Inflation Control Strategies. How effective they are?

Inflation in India and across the globe have more than doubled since the beginning of the year 2008. (India witnessed a sharp rise in inflation from 3-6% a year ago to around 12% this year. )

What comes to our mind when we see a rise in inflation data is the 'typical' remedy action by the central bank- Strict monetary regulation by an increase in bank lending rates.
RBI does this everytime inflation skyrockets,with the hope of bringing it down.

But how effective are these stepS?

I always beleive in the principle that 'do not treat for the disease..instead treat for the cause' 
With this in mind, let me throw some light into the causes of inflation.

Inflation is defined as the general rise in prices of goods and services. It can also be thought of
as the decrease in purchasing power of money.

The most commmon types of inflation are cost-push and demand-pull inflations.
Demand pull inflation occurs when the demand of a product exceeds its supply leading to rise in prices.
Cost push inflation occurs when cost of production increases leading to rise in retail prices..

If we analyze the 2 types of inflation, it is clear that if we can increase the production or decrease cost of production, inflation can be brought down.

But, does the RBI policy of decreasing money availability lead to any of the above??
RBI is trying to absorb money available for spending by increasing the interest rates. The purpose of doing this,as claimed by RBI, is to reduce the demand of goods and thereby leading to drop in prices.

What if we,instead of reducing demand, increase the supply of goods?? Wouldn't that solve the problem of inflation better?? It doesn't lead to unemployement also, as increasing production obviously increases employement..
In current scenario, if inflation is getting higher and suppose that if industries decide to increase the supply of goods to fight inflation, they will find it difficult as the interest rates are high!!!

So if RBI can reduce the rate of interest to basic industries, and agro products then we can bring down the production cost and can produce a lot more, leading to drop in inflation. History has shown that all major economic recession in world was accompanied by rise in food prices. (even the current financial meltown also) If govt. could increase the money suppy to basic industry like base metals, agiculture products. in times of inflation, we could control inflation much better!!

Cijo Thomas

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