If you speak to someone of the older generation, it is not long before they will start saying something like:
“When I was a lad, you could get a pint of beer for only 10p, it’s outrageous how much it costs these days”
Economies are more likely to experience inflation than deflation.
Price is a function of demand and supply. If there is more demand than supply prices will be more and vice versa. The chronic rise in prices is called inflation. It affects more who are least able to bear it, i.e. labourers, pensioners and other fixed income groups whose income increase does not match the rise in prices.
There are many reasons why prices rise. One is demand pull, the ie rise in prices due to increase in demand relative to supply. Another is due to increase in the cost of production due to rise in prices of raw materials.
Besides prices also rise is due to increase in money supply. If govt expenditure is more than its revenue income, it resorts to deficit financing. It is a short-term measure to tide over a shortage in income through printing money.
If deficit financing is done for consumption purposes, it leads to price rise because consumption expenditure is unproductive and does not increase any new asset. But money income is increased and with same supply of goods and services prices tend to rise due to rise in demand.
With the increase in money supply, bank deposits increase. Banks keep a negligible amount by way of cash and bank balance. Of course, they keep about 24% of net deposit by way of CRR/SLR with RBi as a statutory reserve. However, they lend most of the balance amount to earn a profit. This adds to money supply and increases prices if the supply of goods remains constant.
Thus in a growing economy money supply grows through currency circulation and bank credit. Of course, RBI regulates money supply through changes in repo/reverse repo rate from time to time.
In the bank, interest is paid in a fixed deposit a/c and if not withdrawn is compounded and paid at the time of maturity. Interest is paid out of income earned by banks from their lending operation.
The process of money creation is very interesting. You can read a book on commercial banking published by Indian Institute of Banking and Finance.
India’s inflation rate and economy
Inflation is generally defined as the increase in prices of goods and services over a certain period of time, as opposed to deflation, which describes a decrease in these prices. Inflation is a significant economic indicator for a country. The inflation rate is the rate at which the general rise in the level of prices, goods and services in an economy occurs and how it affects the cost of living of those living in a particular country. It influences the interest rates paid on savings and mortgage rates but also has a bearing on levels of state pensions and benefits received. A 4 per cent increase in the rate of inflation in 2011, for example, would mean an individual would need to spend 4 per cent more on the goods he was purchasing than he would have done in 2010.
India’s inflation rate has been on the rise over the last decade. However, it has been decreasing slightly since 2010. India’s economy, however, has been doing quite well, with its GDP increasing steadily for years, and its national debt decreasing. The budget balance in relation to GDP is not looking too good, with the state deficit amounting to more than 9 per cent of GDP.