Context: The latest Consumer Price Index data showing resurgence in retail inflation proves exactly why the RBI’s monetary authorities have reiterated the need to keep the policy approach firmly tilted towards ensuring price stability. What causes inflation?
- Supply shocks: Inflation often happens because of supply shocks where major disruptions to an important economic input happen, like energy.
- Money supply: Then there’s the demand side of the equation. An increase in the money supply will tend to cause inflation.
- Expectations and spirals: In many models of inflation, the cause isn’t an increase in the money supply but an unanticipated increase in the money supply. It’s the unexpected increase in demand (or decrease in supply) that sets off inflation.
- Currency-In general, inflation tends to devalue a currency since inflation can be equated with a decrease in a currency’s buying power.
- Bond yields– Rising inflation pushes bond prices lower, thereby pushing yields higher.
- Purchasing Power-This is inflation’s primary and most pervasive effect. An overall rise in prices over time reduces the purchasing power of consumers.
- Bank rate policy: Bank rate policy is used as the main instrument of monetary control during the period of inflation.
- Open Market Operations: To control inflation, the central bank sells the government securities to the public through the banks.
- Fiscal measures- Fiscal measures to control inflation include taxation, government expenditure and public borrowings.