Inflation Case

Article : India Inflation Poses Central Bank In Dilemma

Topic : Inflation and Unemployment

Source : The Wall Street Journal

Summary

This news article reports that the high rising inflation in India making it difficult for the central bank to revive the increasing stagflation risks. Due to the high cost of oil imports and volatile food prices, inflationary pressure has remained a risk.

Analysis

Inflation is defined as the persistent and sustained increase in the price level of goods and services in the economy. As mentioned in the article, India has used wholesale prices to gauge inflationary pressures, for the index has a larger and more-representative basket of commodities than the consumer price index. Hence, they introduce new CPI.

Annual inflation rate = CPI this year-CPI last year CPI last year ×100%

However, it takes a few years to make it to the benchmark. Thus, this approach cannot work in the long run.

The concept of cost-push inflation is relevant to the analysis. Cost-push inflation is an increase in price level resulting from an initial increase in cost of production. Due to the price of oil increase which led to a high cost of oil imports, shifting the SRAS curve to the left. As such,

Figure 1

From the diagram, it is assumed that initial equilibrium is at full-employment. A decrease in aggregate supply shifts the short-run aggregate supply curve to SRAS 1. (SRAS →SRAS1) The economy moves to the point where the SRAS1 intersects the aggregate demand curve (AD). The price level rises to P1 (P0 → P1) and output decreases below full employment. (Yf →Y1), resulting in a recessionary gap. Stagflation