Inflation in India - Essay Example

Inflation is essentially defined as a substantial increase in the prices of goods and services over time. A great deal of economics literature discusses the causes and effects of inflation. High rates of inflation can have critical effects on an economy. This essay broadly discusses these effects. Inflation is an upward movement in the general level of prices over a given period of time. It is characterized by depreciation in the value of money. Economists attribute a number of factors to inflation that can be broadly categorized under supply-side factors like increased production costs and demand-side factors like excessive demand created by tax cuts, cheaper borrowings, etc.

High rates of inflation can have serious consequences for the economy in general. Therefore, for governments all over the world, reducing movements of prices to a minimum is seen as a primary economic objective. A wide variety of economic literature deals with the effects of inflation. The most widely discussed outcome of inflation is unemployment. In price-sensitive markets, rising prices result in businesses losing sales and thus reduced turnover. This ultimately affects employment as the firms engage in cutting manpower labor to reduce costs.

Additionally, rising prices during inflation create unrest among labor. Inflation encourages employees to demand higher wages in order to maintain their current living standards. The worst hit during inflation is the fixed-income groups like pensioners. An increase in wages during inflation can fuel an additional increase in product prices. This results in a vicious circle of increased wages further increasing prices which in turn would push up the wages again. In economic terms, this 'wage/prices inflationary spiral' can have disastrous effects on any economy.

(Worthington & Britton, 1997) Depreciation in the monetary value results in falling purchasing power and wipes out past savings. Inflation also affects market sentiments of risk-taking. Entrepreneurs become unwilling to invest in new projects if inflation is unlikely to fall. This would affect the gross capital formation of an economy negatively. The above effects can be exemplified by taking the current scenario of the Indian economy. Annual Inflation in India in May 2008 was 7.4% which was the highest since November 2004.

As a result Industrial production growth declined to 8.6 % in February 2008 as compared to 11 % in February 2007. (Raman, 2008) Thus to sum up, a high inflationary rate is harmful because the value of the money falls, the cost of living rises, reduces the value of savings, discourages future investment and savings, and slows down the overall growth of the economy.