Unit – 3 : MONEY SUPPLY & INFLATION
1) Money is anything which performs the following four functions:
- Medium of Exchange - A measure of value
- A store of value over time - Standard for deferred payments
2) Medium of Exchange: Individual goods and services and other physical assets, are “priced” in terms of money and are exchanged using money.
3) A Measure of Value: Money is used to measure and record the value of goods or services.
4) A Store of value over time: Money can be held over a period of time and used to finance future payments.
5) Standard for Deferred Payments: Money is used as an agreed measure of future receipts and payments in contracts.
6) Money supply refers to the stock of money in circulation in the economy at a given point of time. This is partly exogenous (Decided by the Govt and the RBI) and partly endogenous.
7) There are four common measures of Money supply, commonly used in India:
- Narrow Money (M1)= Currency with Public Demand Deposits with Banking System + ‘Other” Deposits with the RBI
- M2 = M1+ Savings deposits of Post Office Savings Banks
- M3 = M1+ Time Deposits with the Banking System
- M4 = M3+ All Deposits with post office savings banks ( Excluding NSCs)
8) Currency with Public = Currency in circulation - Cash held by banks.
9) Demand Deposits = All liabilities which are payable on demand and they include current Deposits, demand liabilities portion of saving Banks Deposits, margins held Against LC/BG, Balance in OD FDs, Cash Certificates and Cumulative/RDs etc.
10) “Time Deposits”= which are payable otherwise than on demand and they include fixed Deposits, Cash Certificates, Cumulative and recurring Deposits, time Liabilities portion of savings bank deposits, etc.
11) The concept of Inflation refers to a sustained rise in the general level of prices of goods and services in an economy over a period of time.
12) Inflation leads to fall in purchasing power.
13) Causes of Inflation:
- Demand-pull inflation - Cost – Push Inflation
14) Demand – pull Inflation is a rise in general prices caused by increasing aggregate demand for goods and services.
15) Cost- Push Inflation is a type of inflation caused by substantial increases in the cost of production of important goods of services, where no suitable alternative is available.
16) Measure of Inflation: - Calculating inflation with Price Indexes
17) Inflation = (Price Index in Current Year–Price index in Base Year) X 100/Price index in Base Year
18) There are 4 Important Price Indexes
- Wholesale Price Index (WPI) - Food Inflation Index (FII)
- Consumer Price Index (CPI) - GDP Deflator
19) Wholesale Price Index: The WPI reflects the change in the level of prices of a basket of goods at the wholesale level. WPI focuses on the price of goods traded between corporations at the wholesale stage, rather than goods bought by consumers.
20) In India WPI (Headline Inflation) is the official inflation index used for policy decisions.
21) WPI announced in Monthly frequency.
22) The different components along with their weightage in Wholesale Price Index (WPI).
Food Articles 15.4025
Non Food Articles 6.1381
Sub Total 22.0253
Fuel, Power, Light & Lubricants
Coal Mining 1.7529
Mineral Oils 6.9896
Sub Total 14.2262
Food Products 11.5378
Beverages, Tobacco and Tobacco Products 1.3391
Wood and Wood Products 0.1731
Paper and Paper Products 2.0440
Leather and Leather Products 1.0193
Rubber and Plastic Products 2.3882
Chemicals and Chemical Products 11.9312
Non-Metallic Mineral Products 2.5159
Machinery and Machine Tools 8.3633
Transport Equipment and Parts 4.2948
Basic Metals and Alloys 8.3419
Sub Total 63.7485
Grand Total 100.00
23) The Base year for WPI is 1993-94.
24) From August 2010 onwards, Base Year for WPI is changed to 2004-05. And the weightage are as follows: (Source: Business Line 15-09-10)
25) The Indices for the Food Group and fuel group will be announced on weekly basis.
26) Consumer Price Index (CPI): The CPI reflects the change in the level of prices of a basket of Goods and services purchased/consumed by the households.
27) CPI is the cost of living index popularly known as Core Inflation.
28) There are four measures of CPI,
- The CPI for Industrial Workers (IW) has a broader coverage than the others
- The CPIs for Agricultural Labourers (AL),
- Rural Labourers (RL) - And Urban Non-Manual Employees (UNME).
29) In the organized sector, CPI-IW is used as a cost of living index.
30) Among the four measures of CPI, the CPI for Industrial Workers (IW) has a broader coverage than the others.
31) Why do the WPI and the CPIs differ?
They differ in terms of their weighting pattern. First, food has a larger weight in CPIs - ranging from 46 per cent in CPI-IW to 69 per cent in CPI-AL, whereas it has a weight of only 27 per cent in the WPI. The CPIs are, therefore, more sensitive to changes in prices of food items.
32) CPI in India is released by Labour Bureau, Ministry of Labour and Employment, Government of India.
33) Since 1943 the Central Government took upon itself the job of compilation and maintenance of Consumer Price Index Numbers in pursuance of the recommendations of the Rau Court of Enquiry.
34) The Consumer Price Index Numbers for Industrial Workers (CPI-IW) for 50 centers and All-India weighted index on base 1960=100 was started on the basis of the Weighting Diagram drawn by conducting the Family Living Survey (FLS) in 1958-59.
35) The current series (1982=100) replaced the old (1960=100) series with effect from October, 88.
36) GDP Deflator: it is measure of the level of prices of all new, domestically produced, final Goods and services in an economy.
37) GDP deflator is not based in a fixed basket of Goods and services