Consider the following :
(a) Creeping inflation is condusive for economic growth and may have favourable effects.
(b) During inflation value of money increases.
(c) Inflation benefits debtors.
(d) Inf

Question

Consider the following :
(a) Creeping inflation is condusive for economic growth and may have favourable effects.
(b) During inflation value of money increases.
(c) Inflation benefits debtors.
(d) Inflation decreases the inequality of income.
Which of the statement/s given above is/are correct ?

UnlockIAS · Accepted Answer

Correct — option (4), which accepts statements (a) and (c) and no others. Statement (a) is sound. Creeping inflation is a mild rise in the general price level, in the low single digits year on year, and it is generally regarded as favourable for growth: gently rising prices mean gently rising profit margins, which encourages producers to invest and expand output and employment, and they keep the economy away from deflation, in which falling prices lead buyers to postpone purchases and debts become heavier in real terms. That is why central banks target a small positive rate of inflation rather than zero — the Reserve Bank of India's target under the flexible inflation targeting framework is four per cent consumer price inflation with a tolerance band of two to six per cent, given statutory footing by the 2016 amendment to the Reserve Bank of India Act, 1934. Statement (c) is also sound, and it follows from what inflation does to a debt of fixed money value. A borrower who has contracted to repay a fixed number of rupees repays them in money that buys less than the money he borrowed, so the real burden of the debt falls; the lender bears the corresponding loss. That is why unanticipated inflation is described as a transfer from creditors to debtors, and it applies to governments as much as to households, since inflation erodes the real value of public debt. Statement (b) fails: the value of money means its purchasing power, and purchasing power moves inversely with the price level, so during inflation the value of money falls, not rises. Statement (d) fails too: inflation generally widens income inequality rather than narrowing it. With (a) and (c) standing and (b) and (d) failing, option (4) is the row that matches.

Why the other options are wrong — (a) This row accepts only the statement about creeping inflation and rejects the statement that inflation benefits debtors, but the second is as well established as the first. A debt fixed in money terms loses real value as prices rise: a borrower repays the same number of rupees with money that commands fewer goods, so the real burden of repayment falls, and the gain to the borrower is exactly the loss to the lender. This is one of the oldest propositions in monetary economics, and it is the reason lenders build an inflation premium into nominal interest rates and the reason inflation erodes the real value of government debt. Rejecting it leaves this row with one true statement out of two, which is not enough when a row accepting both is on offer.  (b) This row accepts the three statements the question does not support and rejects the one about creeping inflation that it does. Its first claim, that the value of money increases during inflation, inverts the definition: the value of money is its purchasing power, purchasing power is the reciprocal of the price level, and inflation is by definition a rise in the price level, so money buys less. Its third claim, that inflation decreases the inequality of income, runs against how the burden actually falls: fixed-income groups such as pensioners, salaried employees on slow-moving pay scales and holders of money savings lose, while profit earners, traders and owners of land, property and shares tend to gain, so the spread of real incomes widens. The row is worth studying as a checklist of the three commonest misconceptions about inflation.  (c) This row accepts the claim that the value of money increases during inflation and the claim that inflation decreases income inequality, and both fail. On the first, the value of money is what a unit of money will buy, so a general rise in prices is the same event as a fall in the value of money, described from the other side; a candidate who chooses this row has usually confused the value of money with the quantity of money or with the nominal value of incomes, which do rise. On the second, inflation redistributes towards those whose incomes adjust quickly or who hold real assets and away from those on fixed money incomes, and it also works as a regressive tax, since the poor hold a larger share of their wealth in cash. Both effects widen inequality rather than narrowing it.

Concept: Inflation is a sustained rise in the general price level, and its mirror image is a fall in the value or purchasing power of money. Economists classify it by speed — creeping inflation of a few per cent a year, walking or trotting inflation of moderate single digits, running inflation in double digits, and galloping inflation or hyperinflation beyond that — and by cause, into demand-pull inflation, where aggregate demand outruns the economy's capacity to supply, and cost-push inflation, where rising input costs such as wages, oil or imported materials push prices up. India measures it through the Consumer Price Index, which is the target variable for monetary policy, and the Wholesale Price Index; the Reserve Bank targets four per cent consumer price inflation with a two to six per cent tolerance band, a framework notified in August 2016 and given statutory basis by the amendment of that year to the Reserve Bank of India Act, 1934, with a six-member Monetary Policy Committee setting the policy repo rate. The distributional effects are what this question tests. Inflation favours debtors over creditors, profit earners over fixed-income earners, and holders of real assets over holders of money, and because low-income households hold more of their wealth in cash and have less bargaining power over wages, it usually widens inequality. Mild inflation, however, lubricates growth, which is why the target is a small positive number rather than zero.

State PCS 2021 Q38 — Economy PYQ with Answer

State PCS 2021 Q38 — Economy PYQ with Answer