The way it should be

"It should not escape notice that gold and silver after circulating in every other quarter of the globe, come at length to be absorbed in Hinduston"

                         ~Francois  Bernier

Inflation: Things you dont want to know!

Posted by VASUDEVA REDDY on Wednesday, November 13, 2013 Under: economic articles

Inflation, Repo Rate, Credit policy, GDP et cetera are becoming fancy terms among public. Of course, they are fancy and I am not denying with that. For those who don’t know all those fancy terms, Inflation means the rate at which your money loses its value (Don’t go for bookish definition, it took a semester for me to understand that, yes, I was slow). Higher the value of inflation, faster the eradication in the value of money takes place. Here, my question, is it a good thing or a bad thing?

We need an elaborate answer for that simple question. In developing countries like India, inflation will be always on the higher side, we hardly witness negative inflation levels (deflation, technically). We don’t know much about how negative inflation (deflation) affects the economy, as it hardly happened with India. India never had problems with hyperinflation too, hello! Zimbabwe. Most of the people in Zimbabwe are billionaires but none can afford a coke. The highest level of inflation that recorded after 1801 is 53.8%, in 1943. From, 1969 to 2013, our inflation levels are averaged at 7.7%. We had faced deflation too; the lowest ever recorded inflation value is -11.3% in May, 1976. Interesting thing is, the lowest was recorded within two years of second highest value (34.7%) recorded (Sept, 1974).

As we didn’t witness much of deflation in the history, I want take an example of Japan, a country which has been fighting with deflation for decades. In the last 55 years, Japan’s inflation averaged at 3.2%, which is not our point of interest. From 1999, Japan has been fighting with deflation. In the last 15 years, Japan’s average inflation averaged at -0.25%, in the same period we have been fighting with excessive levels of inflation. We could find an answer if we compare both the economies.

To know what had happened with Japan in that particular period, search for ‘lost decade of Japan’, you can find hundreds of links (or simply, click here ). Japan’s GDP is not even half of what world has predicted their GDP would be in 2013. By 1991, Japan was the second largest economy in the world in any fronts. It was richer than Britain, Germany, Canada and France by a far cry distance, but now, it is poorer than all the mentioned economies. It is not just the thing of past, now the weights have been shifted from Japan to Europe. Europe is potentially facing a risk of deflation. The recent inflation figures shows that finally Japan is coming out of deflation with 1% inflation while Euro Zone facing a risk of deflation with 0.7% inflation level.

In the same 1991, we (India) too faced a crisis. But it was of totally different nature, we were poorer (we are poor, now) and were unable to repay our debts. Fast forward to now, we have one of the biggest forex reserves in the world and we still fight with inflation. India is the second fastest growing nation in terms of GDP, Ranked third in terms of PPP and tenth largest economy in the world. Yes, we have loads of issues to be addressed, but we are far better than what we were in 1991.

One might easily get an idea that inflation is a good thing after reading above comparison. The article hasn’t yet concluded, so, hang on. Yes, it is better to have inflation over deflation, but, not always. There are two worst things than can happen to any economy, firstly, deflation, as we discussed above and secondly, Stagflation. I am sorry to corrupt your mind with these many technical words. In simple words, stagflation means having low growth rates with higher inflation rates. India has faced Stagflation in 70’s and our economy is facing a risk of falling into its trap again. Normally, growth rate and inflation varies proportionally, technically, it should be. But now, we are facing high levels of inflation with low levels of growth rate which is considered to be a deadly combo. With the assumption, if the GDP of country increases everyone of that country will be better-off than yester year, nobody minds to pay more for the same goods (ie, inflation). Conversely, what we are facing now is lesser GDP growth with higher inflation, so, the prices are rising faster than our financial strength which is definitely not good. 

My point is, inflation is a good thing if it controlled properly and kept in permissible levels. So, what are those permissible levels? It is always a debatable question. Widely accepted levels are 2% for developed economies, 2-4% for developing economies.
Thanks for your time!

In : economic articles 

Tags: inflation india deflation stagflation japan lost decade history economic economy 

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