MONEY AND BANKING (Part – I)

Inflation occurs when there is a general increase in the price of goods and service and a fall in purchasing value of money . Inflation allows debtors (borrowers) to pay creditors (lender) back with money worth less than when it was originally borrowed, which benefits debtors. Thus inflation brings about a redistribution of real wealth in favour of debtors at the cost of creditors. Investors in bonds and securities with fixed interest rates, consumers, fixed income groups pensioners etc. also lose in real terms during inflation.

If there is a 5 percent inflation in a particular week of a month in a year , it means that in comparison to same week of the same month in previous year. the prices of goods have increased by 5 percent. It means inflation is measured on the basis of week. Hence, it is clear that to get a zero rate of inflation, the annual rate of inflation in every week of the year should be zero.

Based on the average of 52 weeks, the inflation was 10.9% in 1994-95 which came down to 4.8% in 1997-98. Hence, Assertion (A) is correct. In 1994-95 India received 4807 million US $ as foreign investment while it received 5353 million US $ in 1997-98. Thus, it is clear that there was minimal increase in foreign investment during that period. Hence, Reason (R) is incorrect.

Inflation denotes rise in general price level in an economy. Deflation is just opposite of inflation which denotes fall in general price level of goods and services in an economy.

'Base effect' refers to a kind of statistical anomaly that causes steep hike or decline in the rate of price rise or fall because the current prices are compared relative to the previous period. If last year's price of certain articles is low and this year it has returned to its normal price, yet the rate of increase, which is relative to the last year's price, is shown high.

Revenue deficit is considered as an unproductive expenditure of the government, which was 3.3% of GDP in the year 1990- 91 and reduced to 2.5% of GDP, in the year 1992-93. It means, unproductive expenditure had been reduced during these years. Budgetary deficit, which is the sum of revenue deficit and capital deficit, had also decreased, because revenue deficit was less than earlier. The concept of budgetary deficit was discontinued in the year 1997-98.

Stagflation or recession-inflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high. All four given factors could potentially contribute to stagflation in the Indian Economy.

Bottleneck inflation is the inflation that takes place when supply falls drastically while demand remains at the same level. This creates excess demand in the economy as the supply cannot match it and thus results in rising of prices. Such situations arise due to supply-side accidents, hazards, mismanagement or inefficient distribution. The government faces a tough time in this situation of inflation. Hence, both Assertion and Reason are true and Reason is the correct explanation of Assertion.

Headline inflation refers to the rate of change in the Consumer Price Index (CPI) Number, which represents the average cost of a standard basket of goods and services consumed by a typical household. Hence, statement (A) is correct.
Core inflation measures the change in average consumer prices after excluding from the CPI certain items of volatile prices such as food and fuel. Hence, statement (B) is also correct.

Core inflation represents the long run trend in the price level and in measuring long run inflation, transitory price changes should be excluded. Thus, core inflation is an inflation measure which excludes transitory or temporary price volatility as in the case of some commodities such as food items, fuel products etc. Hence, core inflation is defined as headline inflation excluding both food inflation and fuel inflation.