Inflation and Deflation


Poverty according to the Human Development Report is the denial of opportunities “to lead a long, healthy, creative life and enjoy a decent standard of living, freedom, dignity, self-respect and the respect of others.

Measurement of Poverty

One of the first attempt to define and measure poverty was done by the working Group of the Planning Commission which defined poverty in terms of, "minimum level of living".

Poverty Line

The amounts required to buy the minimum calorific requirements is quantified in terms of money. The amount required to buy the minimum calorific requirements is quantified in terms of money. It is fixed as 2250 calories for urban and 2500 calories for the rural people.


Inflation is that State in which the prices of goods and services rise on the one hand and value of money falls on the other. When money circulation exceeds the production of goods and services, the state of inflation takes place in the economy.


Inflation created and sustained by excess of aggregate demand for goods and services over aggregate supply. In other words, demand inflation takes place when increase in production lags behind the increase in the money supply.

Cost Push Inflation: 

Inflation which is created and sustained by increase in cost of production which is independent of the state of demand(e.g. Trade unions can bargain for higher wages and hence contribute to inflation).


In this type there is a fall in the output and employment levels. Due to various pressures, the entrepreneurs have to raise the price to maintain their margin of profit. But as they only partially succeed in raising the prices, they are faced with a situation of declining output and investment. Thus, on one side there is a rise in the general price level and on the other side,there is a fall in the output and employment.


Very rapid growth in the rate of inflation in which money loses its value to the point where alternative medium of exchange - such as barter or foreign currency are commonly used. This is also called as Galloping inflation.


Inflation is measured by general price index. General price index measures the change in average prices of goods and  services. A base year is selected and its index is assumed, as 100 and on this basis price index for the current year is calculated. If the index of the current year is below 100, it indicates the state of deflation and, on the contrary, if index of the current year is above 100 it indicates the state of inflation. Inflation rate and the value of money (or the purchasing power of money) are inversely correlated. Hence, the value of money can also be measured with the help of price indices. The value of money declines when price index goes up and vice-versa.


Wholesale Price Index(WPI): WPI is a weighted average of indices covering 447 commodities which are traded in primary , manufacturing and fuel and power sectors. A revived WPI with 2004 - 05 as the base year is being worked out.

Consumer price index(CPI): CPI is the retail price average of the basket of goods and services directly consumed by the people.

GDP Deflator: This is arrived at by dividing GDP at current prices by GDP at constant prices in terms of base year prices(ie 2004- 2005)


Various steps have been taken on both demand and supply side to control the inflation rate in the economy.

Steps related to supply side

  • Open market sale of wheat and rice by Indian Food Corporation
  • Wheat and wheat products were brought under the provisions of licensing and storage limit for preventing black marketing of these products.
  • Import of edible oils on 20% import duty and pulses on 5% import duty
  • Import of 2 lakh tonnes Palmolin oil for the sale under public distribution system.
  • To ensure the sufficient supply of sugar, edible oil and pulses, liberalized imports were permitted.

Steps related to demand side:

  • To curtail fiscal deficit upto 5% of GDP.
  • To put a check on money supply increase.


  • Deflation is a state which the value of money rises and the price of goods and services falls.
  • The state of deflation may appear in the economy due to following reasons:
  • When government withdraws money from circulation.
  • When government imposes heavy direct taxes or takes heavy loans from the public(voluntary or compulsory or both).
  • When the central bank sells the securities in open market(which reduces the quantity of money in circulation)
  • When central bank Controls the credit money and adopts various measures such as increase in CRR, credit rationing and direct action.
  • When the Central Bank increases the Bank rate (which curtails the quantity of credit in the economy)
  • when state of over-production(excess supply over demand) takes place in the economy).

Measures of Checking Deflation

  • To increase in money supply.
  • To promote credit creation by the banks.
  • Curtailment in taxes so as to increase the purchasing power of people.
  • To increase the public expenditure and to increase the employment opportunities in the economy.
  • To increase the money supply in circulation by repayment of old public debts.
  • To provide economic subsidy by the Government to the industrial sector of the economy

Deficit Financing is the technique of mobilizing resources through borrowings or printing currency when the revenue of govt. is not adequate to meet its expenditure. It leads to increase in money supply which leads to increase in price level in the absence of increase in supply of consumer goods quickly


Money supply has been increasing continuously with the rise in prices, through the increase rate in money supply has varied from year to year.

On the recommendations of the second working group on money supply, RBI introduced a series of money stock measures in India since 1970 - 1971., which are

  1. M1 —> Money with the Public (currency notes and coins) + Demand deposit of banks(on current and savings bank account) + Other demand deposits with RBI.
  2. M2 —> M1 + Saving bank deposits with Post-offices.
  3. M3 -> M1 + Term deposits with the bank.
  4. M4 -> M3 + All deposit of Post-offices.

M1 measure represents the most liquid form of money among four money stock measure adopted by RBI. As we proceed from M1 to M4, the liquidity gets reduced. In other words M4 posses the lowest liquidity  among all these measures. All these four money stack measures are not of equal importance. Their relative importance varies from the point of view of monetary policy.

Generally in developed countries, the bank deposits are the most important component in money supply, while due to less banking habits in underdeveloped countries people want to keep their money in most liquid form. i.e., currency.

M3 is the most important component among all money stock measures which is generally termed as 'Broad Money'

Cheap Money Policy and Dear Money Policy:

Cheap money policy is that monetary policy in which loans and advances are made available on low interest rate and easy terms to industries, businessmen and consumers. Cheap money policy increases the inflation rate in the economy and it is generally adopted to get rid of deflationary tendencies in the economy.

On the other hand, dear money policy is adopted to squeeze the credit utilization facilities in the economy. Under dear money policy interest rate is increased which helps in controlling inflation in the economy.

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