Inflation, Prices & Monetary Policy

NODE 01

Price

• Monetary value at which a good is exchanged.
• Single price ≠ General price level.
• Price of rice ↑ doesn't automatically mean inflation.

NODE 02

General Price Level

• Average level of prices across a broad basket.
• Inflation concerns this SUSTAINED increase.

NODE 03

Inflation

• Sustained increase in general price level.
• Purchasing power of money falls.
• Each unit of money buys fewer goods.

NODE 04

Inflation Rate

[(P₁ - P₀) / P₀] × 100

• Percentage change in price index over a period.
• E.g., Index 100 → 105 = 5% inflation.

NODE 05

Disinflation

↘

• Inflation is positive, but the RATE is falling.
• E.g., 8% → 6% → 4%.
• Prices still rising, but more slowly.

NODE 06

Deflation

↓

• Sustained DECLINE in general price level.
• E.g., Index 100 → 98 → 96.
• Different from lower inflation rate.

NODE 07

Deflation vs Disinflation

INFL↑ PRICES UP

DISI↗ PRICES UP SLOWER

DEFL↓ PRICES DOWN

• Inflation: Prices generally rising.
• Disinflation: Prices rising slower.
• Deflation: Prices falling.

NODE 08

Deflationary Pressure

• Associated with weak demand, falling incomes.
• Increases real debt burdens.
• Demand ↓ → Production ↓ → Employment ↓.

NODE 09

Types of Inflation

AD→

COST→

IMPT→

• Demand-pull: AD grows faster than capacity.
• Cost-push: Rising production/input costs.
• Imported: External price/exchange rate shifts.

NODE 10

Food Inflation

↑

• Sensitive to weather, crops, logistics.
• Disproportionately affects lower-income households.
• Food is a large share of their expenditure.

NODE 11

Core vs Headline

• Headline: Broad basket.
• Core: Excludes volatile components (food, energy).
• Helps assess underlying price pressures.

NODE 12

Price Index

• Measures change in specified basket vs base period.
• = (Current Cost / Base Cost) × 100.

NODE 13

Consumer Price Index

CPI

• Prices paid by consumers for goods/services.
• Used for cost of living / consumer inflation.

NODE 14

Wholesale Price Index

WPI

• Tracks changes at the wholesale level.
• Differs in basket, coverage, transaction stage.

NODE 15

CPI vs WPI

🛒 vs 🏭

• CPI: Consumer level, highly relevant for policy.
• WPI: Wholesale level, tracks producer trends.
• They answer different measurement questions.

NODE 16

Base Year

• The reference period for a price index.
• Assigned an index value, commonly 100.
• Changes measured relative to it.

NODE 17

Weighted Price Index

• Not every item has equal importance.
• Weights assigned by economic significance.
• E.g., Food gets large weight in household CPI.

NODE 18

Purchasing Power

↓

• Goods/services one unit of money can buy.
• Prices ↑ → Purchasing power ↓.
• Inflation erodes purchasing power.

NODE 19

Nominal vs Real Values

NOM

REL

• Nominal: Current prices (Inflated).
• Real: Adjusted to remove price changes.
• If Salary +5% but Inflation +7% → Real value fell.

NODE 20

Real Interest Rate

NOM-INF=REAL

• Real rate ≈ Nominal rate − Inflation rate.
• Exact: [(1+nom)/(1+inf)] - 1.
• E.g., 8% nominal - 5% inflation = 3% real.

NODE 21

Effects of Inflation

☺☹ ☹☺

• Affects consumers, workers, savers, borrowers.
• Depends on inflation rate and contracts.
• Creates winners and losers.

NODE 22

Inflation & Savers

🔥

• If return on savings < inflation:
• Real return is negative.
• Purchasing power of savings declines.

NODE 23

Inflation & Borrowers

↑

• Unexpected inflation reduces real debt burden.
• Fixed nominal debt becomes easier to pay.
• But lenders may demand higher rates later.

NODE 24

Inflation & Wages

vs ₹↑

• Wages rise slower than prices → Real wages ↓.
• Wages rise faster than prices → Real wages ↑.
• Nominal wage growth ≠ higher living standards.

NODE 25

Inflation Expectations

• Expectations drive behavior.
• Workers expect ↑ → Demand higher wages.
• Consumers expect ↑ → Buy now.

NODE 26

Wage-Price Spiral

W/P

• Prices ↑ → Demand higher wages.
• Labour costs ↑ → Firms raise prices.
• Self-reinforcing cycle (not automatic).

NODE 27

Monetary Policy

₹

• Central bank actions to influence conditions.
• Pursues macroeconomic objectives.
• In India: Conducted by RBI.

NODE 28

Primary Objective

• Price stability.
• While keeping in mind objective of growth.
• Uses inflation-targeting framework.

NODE 29

Policy Rate

• Influences financial conditions.
• Policy rate → market rates → bank rates.
• Affects borrowing, demand, inflation.

NODE 30

Repo Rate

%

• Key RBI monetary-policy rate.
• Higher rate = raises cost of short-term funds.
• Tightens financial conditions.

NODE 31

Monetary Tightening

• Making conditions less accommodative.
• Credit growth ↓ → Demand ↓ → Inflation ↓.
• Can also weaken output and employment.

NODE 32

Monetary Easing

• Making conditions more accommodative.
• Borrowing costs ↓ → Demand ↑.
• Risk: Inflationary pressure if near capacity.

NODE 33

Open Market Ops (OMO)

↔

• RBI buying/selling government securities.
• Buys = Liquidity injected.
• Sells = Liquidity absorbed.

NODE 34

CRR

CASH

• Cash Reserve Ratio.
• Proportion of liabilities kept as cash with RBI.
• CRR ↑ → Lendable funds ↓.

NODE 35

SLR

LIQUID

• Statutory Liquidity Ratio.
• Specified liquid assets relative to liabilities.
• Framework for bank liquidity.

NODE 36

Liquidity

• Availability of funds for payment/settlement.
• Liquidity ↑ = easier financial conditions.
• Liquidity ↓ = tighter financial conditions.

NODE 37

Interest Rate Channel

→

• RBI Policy → Interest Rates.
• → Borrowing cost → Consumption/Investment.
• → Aggregate demand → Output/Inflation.

NODE 38

Credit Channel

>>

• Affects availability and cost of credit.
• Tighter policy = tighter financing conditions.
• Crucial in credit-dependent economies.

NODE 39

Exchange Rate Channel

₹ vs $

• Rates influence capital flows & exchange rates.
• Affects import prices, export competitiveness.
• Monetary Policy → FX → Domestic Inflation.

NODE 40

Asset-Price Channel

↑

• Rates influence bond, equity, property prices.
• Affects wealth, borrowing conditions.
• Drives investment and consumption.

NODE 41

Monetary Transmission

• RBI Decision → Rates/Liquidity → Bank Rates.
• → Credit/Saving → AD → Output/Inflation.
• Chain reaction through the economy.

NODE 42

Phillips Curve

• Relationship between inflation & unemployment.
• Short-run: lower unemployment ↔ higher inflation.
• Not a fixed or permanent relationship.

NODE 43

Stagflation

+

• High inflation + weak growth + high unemployment.
• Inflation isn't always excess demand.
• Realms 10 (output) and 11 (inflation) meet here.

NODE 44

Inflation Targeting

• Aiming to keep inflation around specified target.
• Assessment → Decision → Transmission → Outcome.

NODE 45

Supply-Side Inflation

⚡

• Cannot be solved purely by higher interest rates.
• Crop failure, oil shock, supply-chain breaks.
• Tightening reduces demand, doesn't create food/oil.

NODE 46

Policy Limitations

• Long and variable lags.
• Weak transmission, supply shocks.
• Rate change ≠ immediate predictable result.

NODE 47

Inflation & Fiscal Policy

🤝

• Monetary and fiscal policy interact.
• Fiscal expansion vs Monetary tightening.
• Stabilization requires coordination.

NODE 48

Good vs Bad Deflation

⚙📉

• Good: Tech makes a product cheaper.
• Bad: General price level falls persistently (debt/demand issues).

NODE 49

Price Stability

• Not every price remains permanently unchanged.
• Individual prices change by supply/demand.
• Avoiding persistent/destabilizing general price shifts.

NODE 50

Master Price Chain

• Supply+Demand+Costs+Expectations → Price Level.
• → Inflation/Deflation → Purchasing Power.
• → Real Income → Cons/Sav/Inv.

NODE 51

Master Monetary Chain

• RBI Assessment → Rates/Liquidity → Banks.
• → Interest Rates + Credit → Households/Firms.
• → Aggregate Demand → Output/Inflation.

NODE 52

Formula Bank

R = N - I

• Inflation Rate = [(Pₜ − Pₜ₋₁) / Pₜ₋₁] × 100.
• Index = (Current cost / Base cost) × 100.
• Real Rate ≈ Nominal Rate − Inflation.