Indian inflation rises to yearly high of 9.78%
As the article states, the inflation in India is caused ‘due to the rising costs of food, fuel and manufactured goods’. Possible types of inflation occurring in the country include –Cost-push and Demand-pull inflation.
Cost-push inflation occurs when there is an increase in the costs of production.
According to the diagram above, we can see that as the cost rise, the short-run AS falls from SRAS1 to SRAS2. This therefore results in an increase in the average price level from P1 to P2 and a decrease in the output from Y1 to Y2. This increase in the cost of production could be due to increase in the average wage levels perhaps due to minimum wage laws and trade union enforcement. Increases in resources, capital creates cost-push pressures on firms. Also, the fall in the value of India’s currency is a possible cause for the inflation. This can be explained by the lower exchange rate, which could make imported capital and raw materials more costly therefore increasing the costs of production.
On the other hand, demand-pull inflation happens due to the increase in AD in the economy. A possible cause for demand-pull inflation is when the economy is approaching full unemployment.
According to the graph above, we can see that as the economy almost reaches full employment level of income, there is a small amount of spare capacity. The increase in AD from AD1 to AD2, results in an increase in the real output from Y1 to Y2. Therefore the increase in the AD brings up the average price level which can be caused due to any changes in any of the components of AD in an economy.
India’s government can manage the inflation using policies specific to the type of inflation. If the inflation is due to excess demand (demand-pull) then the government could reduce the AD in the economy using implementing a deflationary fiscal policy that increases taxes and lowers government spending. Another policy to combat demand-pull inflation would be deflationary monetary policy that raises the interest rates and reduces the money supply in the economy. Cost-push inflation can be managed by reducing income taxes, reducing corporation taxes, reducing trade union power and eliminating or reducing minimum wages.