Inflation AS

Inflation AS - Transcript

Inflation Definition

A continuous and sustained rise in the general price level over a period of time

02 20 11

S Prusty

1

Trends of WPI in India April 1994 August 2007 Base 1993 94 100
220 0 200 0 180 0 WPI 160 0 140 0 120 0 100 0
Ap r 9 4 Ap r 9 5 Ap r 9 6 Ap r 9 7 Ap r 9 8 Ap r 9 9 Ap r 0 0 Ap r 0 1 Ap r 0 2 Ap r 0 3 Ap r 0 4 Ap r 0 5 Ap r 0 6 Ap r 0 7

Months

02 20 11

S Prusty

2

Inflation Theoretical View
Classical Approach believing in QTM MV PT assuming V and T are constant in short run there is a direct and proportionate relationship flowing from money supply to price level Thus inflation occurs in an economy only due to money supply growth
02 20 11 S Prusty 3

Inflation Theoretical View
Keynesian Approach Inflation occurs in an economy when Aggregate Demand increases beyond the full employment level of output N B Aggregate Supply curve is vertical at full employment level of output

02 20 11

S Prusty

4

25 0

Trends in Growth Rates of Real NDP Broad Money in India 1952 2007

20 0

15 0

10 0

5 0

0 0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55

5 0

Growth Rate of NDPfcconp Growth Rate of Broad Money

10 0 Y ear

02 20 11

S Prusty

5

Inflation Theoretical View
Structural Approach Inflation occurs in an economy due to supply shocks and external factors such as famine flood War and increase in international crude oil price

02 20 11

S Prusty

6

Causes of Inflation
Causes of Demand Pull Inflation Population Growth Deficit Financing and Money Supply Growth Causes of Cost Push Supply Shock Inflation Increase in Money Wage Wage Push Increase in Profit Margin Profit Push Increase in Indirect Tax Rates Increase in International Crude Oil Price Famine Flood War
02 20 11 S Prusty 7

Causes of Inflation in India
1955 56 to 1960 61 Establishment of basic and key industries whose gestation period is long 1962 63 China attacked India 1965 66 Indo Pak War Famine 1972 73 Increase in Bangladesh Refugees Failure of Kharif Crop 1973 74 First Oil Shock Increase in crude oil prices by OPEC
02 20 11 S Prusty 8

Causes of Inflation in India
1974 75 Devaluation of Rupee 1979 80 to 1981 82 Poor Harvest and Second Oil Shock 130 increase in oil prices in 1980 1990 91 to 1992 93 Increase in Prices of foodgrains vegetables sugar and edible oils and Third Oil Shock due to Gulf War 1998 99 to 2000 01 Increase in Prices of Primary Articles Shortage in supply of Onion Oilseeds etc
02 20 11 S Prusty 9

Economic Impact of Inflation
Inflation is having adverse impact on Fixed Income Groups Creditors Bondholders and Governments fiscal position Inflation is having positive impact on Entrepreneurs Profit Debtors

02 20 11

S Prusty

10

Aggregate Supply Wages Prices and Employment
Classical Theory Labour Market is always at full employment i e no nonfrictional unemployment as prices wages adjust rapidly In practice
labour market adjust slowly to changes in aggregate demand AD unemployment rate is not always at the natural level slow adjustment of output to changes in AD
02 20 11 S Prusty 11

The Dynamic Return to LongRun Aggregate Supply

02 20 11

S Prusty

12

Nonlinear Aggregate Supply

02 20 11

S Prusty

13

Phillips Curve A W Phillips 1958 The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom 18611957 Economica

02 20 11

S Prusty

14

The Original Phillips Curve for the United Kingdom

02 20 11

S Prusty

15

Phillips Curve
Establishes an inverse relationship between rate of wage inflation gw W W 1 W 1 and u u unemployment rate
Where u is the unemployment rate in an economy and u is the natural rate of unemployment caused by structural and frictional forces which cannot be reduced by an increase in demand

Phillips Curve function gw u u Or W W 1 1 u u when u u wages are falling W W 1 when u u wages are


rising W W 1 wages prices adjust slowly to AD 02 20 11 S Prusty 16

Phillips Curve
From the dispersion of the data points Phillips concluded that there was a countercyclical loop
Money wages rise faster as unemployment decreases Money wages fall slower as unemployment increases Implies an inflationary bias and is consistent with sticky wage theory
02 20 11 S Prusty 17

The Policy Tradeoff Relationship of Inflation and Unemployment U S 1961 1969

02 20 11

S Prusty

18

Inflation Employment in India 1971 2005
Inflation CPI IW Employment Private Public Sector Employment in the Organized Sector
SUMMARY OUTPUT Regression Statistics Multiple R 0 780099724 R Square 0 60855558 0 596693628 Adjusted R Square Standard Error 21 58019849 Observations 35 ANOVA df Regression Residual Total 1 33 34 SS 23892 13456 15368 26391 39260 39847 MS 23892 13 465 705 F Significance F 3 30093E 08 51 30316

Intercept X Variable 1

Coefficients Standard Error t Stat 153 070674 27 88058142 5 490225 0 008059515 0 001125219 7 162622

P value 4 34E 06 3 3E 08

Lower 95 209 7941432 0 005770241

02 20 11

S Prusty

19

Thanks

02 20 11

S Prusty

20