The higher the rate of interest, the greater the cost of borrowing from the banks by the business firms. This implies that those who held claims on assets fixed in nominal terms in 1996, their real value in terms of purchasing power would have declined significantly. . As suggested by some economists, to control hyperinflation some type of control on wages often called incomes policy was needed. Therefore, an increase in the cost of a raw material led to a lower supply of oil, and with demand being unchanged, the rise in the price of oil led to an increase in the general price level.
Cost-push inflation is shown on the diagram below. This is known as Fischer effect which states that market or nominal rate of interest is equal to the real rate of interest based on productivity of capital and rate of time preference plus the anticipated rate of inflation. Thus, the price level has risen because aggregate demand has increased relatively more than the aggregate supply, that is, due to demand-supply imbalances. The sharp rise in world oil prices during 1973-75 and again in 1979-80 produced significant supply shocks resulting in cost-push inflation. The aggregate supply curve shifts left, because of the cost increase, pushing prices up.
In the extreme when as a result of issuing too much money supply to finance government deficit or working of wage-price spiral, inflation becomes extremely rapid or what economists called hyperinflation, normal working of the economy collapses. By law banks have to keep a certain proportion of cash money as reserves against their demand and time deposits. Anticipated and Unanticipated Inflation: The difference between anticipated inflation and unanticipated inflation is of crucial importance as the effects of inflation, especially its redistributive effect, depend on whether it is anticipated or not. Businessmen too increase their purchases of capital goods and build up larger than normal inventories if they anticipate rise in prices. The aggregate demand and supply analysis helps in explaining the short run fluctuations in the economic activity around its long run trend. Last updated 7th June 2017. If aggregate supply of output does not increase or increases by a relatively less amount in the short run, this will cause demand-supply imbalances which will lead to demand-pull inflation in the economy, that is, general rise in price level.
Therefore, demand-pull inflation generally occurs when the economy is already working at full-employment level of resources or what is now generally called when there is natural rate of unemployment. In the revenue budget on the receipts side revenue raised through taxes, interests, fees, surpluses from public undertakings are given and on the expenditure side consumption expenditure by the government on goods and services required to meet the needs of defence, civil administration, education and health services, subsidies on food, fertilizers and exports, and interest payments on the loans taken by it in the previous years are important items. These people often enter into contract with the employers regarding wages or salaries fixed in nominal terms. Surprisingly, I got more than what I expected. Instruments like repo rate and reverse repo rate have often been used to manage aggregate demand. They have even to incur expenditure on advertisements to inform the public about their new prices.
It may be noted that rise in oil prices not only gives rise to the increase in inflation, but also adversely affects the balance of payments raising current account deficit of the oil-importing countries such as India. This type of inflation is usually seen when there is a strong labor union. Rising wages are a key cause of cost push inflation because wages are the most significant cost for many firms. So I switched to this assignment help site for a simple and easy solution. For creditors including financial institutions such as banks and insurance companies who enter into agreement with the borrowers to provide loans at fixed nominal rate of interest, the real value of money in terms of goods and services which they will receive at the end of the period would be much less if during the period prices rise sharply.
Limitations of Tight Monetary Policy : However, tight monetary policy for controlling inflation is not without its limitations. Farm Price Shock: Cost-push inflation can also come about from increase in prices of other raw materials, especially farm products, in economies such as that of India where they are of greater importance. At that time, money depreciated so much that for some time barter system came to prevail and after some time, the new currency had to be issued. Self-sustaining upward trend in general price levels fueled by the reinforcing feedback of a vicious circle. Now, when due to increase in raw material prices or oil price shock price level of output has risen as a result of cost-push effect, the workers would revise upward their expectations of price level. Measures to Control Cost-Push Inflation Most often governments intend to implement a deflationary fiscal policy such as higher taxes, lower spending etc.
This is how inflationary expectations cause inflation. Accordingly, cost- push inflation can take the forms of wage-push or profit- push or material-push inflation. This brings the aggregate supply to the right, fixing cost push inflation. However, inflation will occur by this new investment if aggregate supply of output does not increase adequately in the short run to match the increase in aggregate demand. Pandit of Delhi School of Economics has also felt the need for distinguishing price behaviour in the Indian agricultural sector from that in the manufacturing sector. The Government and Central Bank are likely to adopt expansionary monetary and fiscal policies in order to avoid recession.
The driving force in the process of economic growth, according to them, has been high profit margins created by inflation. But after some minutes collecting all my strength and confidence, I step forward and solved the problem. For example, in the month of June 2013, there was sharp depreciation of the Indian rupee. On the other hand, monetarists explain the emergence of excess demand and the resultant rise in prices on account of the increase in money supply in the economy. It may also be noted that if inflation is anticipated and all expect equal rates of inflation the nominal rates of interest are adjusted upward so as to obtain targeted real rate of interest. That is, unanticipated inflation catches you by surprise. The rise in interest rate crowds out private investment.