Inflation (Afrati zar)

Inflation (Afrati zar)

Does money depreciate in value?

In simple terms money is a medium of exchange, but when we talk in broader sense, money is a commodity, which is generally acceptable in final payment of dues.  Money is also known as “gigantic confidence trick” – means money has power. The value of money, like that of any other commodity, is subject to fluctuations.  Any decrease in the value of money as a result of variation in the demand and supply of goods is called depreciation in its value. When we can buy more good for a unit of money than before, the value of money rises, but when we can buy less goods for same unit than before, the value of money falls.  As a matter of fact, depreciation in the value of money disturbs the even basis of an individual’s consumption and saving.  In order to maintain the standard of living, a consumer has to spend more money than before because of wearing down in the value of money available with him. Alternatively, the consumer refers this absurdity to an increase in the prices of goods and services required by him. Obviously, such an increase in the prices calls upon the consumer to possess more quantity of money.  Sometimes it so happens that the government deliberately increases the volume of currency in a period of such monetary and financial inflexibility till it exceeds the legitimate currency requirement of the country.  Such deliberate increase in the volume of currency in excess of legitimate demand for it is called Afrati-zar or inflation. Afrati-zar - depreciates the values of the money and raises the general price level. 

It is believed that a mild degree of Afrati-zar – increase in prices is necessary for the growth of an economy but if the prices increase beyond a particular limit, it may prove dangerous for the economy.  Here, it is to understand as why does the money depreciate and cause a rise in the prices. Two important factors are responsible for it. 1) limited supplies and 2) increasing demand.  Limited supplied is a result of stagnant agricultural/industrial production and high prices of imports while as increasing demand is an off-shoot of increasing population and public expenditure, deficit financing and increased money supply. Other factors responsible for rising prices are hoarding, defective distribution system, poor resistance from consumers and more or less unstable political conditions in a country.

Measuring inflation is a difficult task. To do so a number of goods that are representative of the economy are put together into what is referred as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year. In India two types of index: Consumer Price Index (CPI) and Wholesale Price Index (WPI) are used to monitor inflation. Off the two, Wholesale Price Index (WPI) is the most widely used price index in India. It is used to measure the change in the average price level of goods traded in wholesale market.

Afrati-zar leaves its negative effect on people’s ability to save because they have to spend more to maintain their given level of living.  Ultimately it keeps holding the country’s real capital stock and does not allow it to increase.  Some economists have aptly called it as a “legal robbery”. In order to check this menace of Afrati-zar (or inflation/deprecation of money), economy needs to regulate the supply of money in it. The idea can squarely come to grips if the flow of bank credit is regulated both in terms of its quantity as well as availability.  This task is generally entrusted to the central bank of a country. Further, government has to set up an efficient system to mop-up the excess purchasing power available with the individuals in the country and raise the output by adopting both short term and long terms measures.  Compulsory and voluntary savings schemes and the honest payment of the taxes reduce the purchasing power of the community and helps greatly in the control of price rise.  Temporary measures like the price control and rationing also help.  But for a sustained control over price rise, it is imperative to keep raising the output to the level of existing demand.  At a micro level some people are wise enough to hedge their savings against deprecation by investing in lucrative schemes of banks or by sinking it into other judiciously economic channels. 

India has been seriously suffering from the problem of Afrati-zar and had at times more than 10%. These days it is hovering at the satisfactorily level of around 4% because of measures taken by the RBI like raising CRR (cash reserve ratio – a cash balance required to be kept with RBI by banks) from last so many years besides rapier cut in the prices of essential commodities and above all a good output in agricultural sector. 

Uncertainty about the level of future inflation adversely affects the economy because it distorts the savings and investment decisions of households and businesses. Since these decisions typically involve planning horizons of many years, the adverse effects from inflation uncertainty can be reduced by adopting a policy framework that makes future inflation more predictable over long time horizons. We have not to get lost in different ideologies but encourage those industries and production units, which can increase the supply of goods.  Government has to keep all profiteering and hoarding activities under control. Check on prices has to be the most important component of any policy that may be drawn up by the policy makers to make use of the existing opportunities to save for the sustained growth of the economy itself.