I'

I
I Definition: {nflation is c!clincd as the persistcnt rise in ths

r gcncral price levcl o{ gttotls :tnd serr ices in a countr\ lrver

pcriod of time.
I
h

I It is of monel is talling. Wl'ien prices alc rising, the purchasing

a situation where the r alue
porver is also lalling. Pelsistent rise docsn'l mean that all the prices are rising to the sarne

I cxtent Some pliccs mav he lising vcll, shat'plv, othcls ntat'Lrc rising rery littlc, and u i'ew
rla_v be lallinr.

Rate of in flttion is dcfined as .l p€rcentage rise in the gener:rl price levcl of goods
antl scrviccs in a country over a periocl of tirnc.

INFLATION RATE OF MALDIVFS

1!:t

I
'!l

t 6

a !
.-iro, rL-rlir (I Onl

I 'rYPits {}F INt.t.A f IoN

I l- Crrrpnrg inllatiorr is u'hete thc general price lelcl tiscs ai an annual ralc bcl\r,cE-ll I?;
f -,,rd bo o or Lhc lrrrr l. r'el ofirrllation. It is uot ciangcrous. ralh!-r {lcsirablc. 1L lrelps to

I 2.
boost thc cconomy.
Ilypcrinflation is en inllutiorar'1' siluation iihete gcnctal ftiet' ls'cl liscs aL a
phenornenal ratc. It is also descril-.ecl as a gollopirr-ll. it rllrrrl\\'a\', a sklrocl<clint

I inllalion. This i)llc ot inllatiorilr\ s Ill.llioir in . r t!,,rli'lll\ s Ltt,clesirable beclttse thc

value o1'nonev is persistently falling rrncl also petrple rr i11 lose corriidencc irr thc
functions ol nronct' as l Inccli,.tttt ol crchlttge. rlreilns ol-pitvlttcltt iitt(l c\,atl \lore ot'
I 3.
llluc clc.
SupXrrcssct! in{lation occurs r.;hcrc clctlancl lirr goocls attcl se|liccs ercced -Ltpplr bu
iL is conLlollccl which i:; retlectecl in lrtiorring. shoriales, en'.1 bluck-nratkct pliccs.

ttD.t/.tet:D.tt / e tt'.oz \)i.r '/t

9r
 M EASL]RING INFLATION-INI)EX NUM tsERS
Mcaning ol:-

+ an lndcx qq4fur';- It dcals u ith pcrccntaltc chrurge s.

+ an index of p!.i!r:s or- l'-!11!l ndC! It is an avclagc ol perccrtagc cllargcs in thc
prices ofa nurnber of dii'fercnt goods and scrviccs

The Rate of inflation is measurcd bl thc

Retail Pricc lndex(RPI) nethod or
Consunrer Pricc Index -

RETAIL PRICE INDEX

+ Rctail Price lndcx (RPl) is a Price index u'hich is uscd to mcil.,ulc llte latc
ol'inflation. lt includes a rvide range ol' goocls and sen,ices. and ailns to
shoN \\'hrt is happcning to the vaLuc of nroney spent bv lhc aletagc
hoLrschold.

+ Or Retail Price Index lltPI) is an inllrtionar'y, indicator lhrt rnertsLlrcs ll'rc

clrangc in thc cost of a lixed basket of retail goods

'0.t,/,t .4\t.trtn /0r9,L.ro ,fot.t tt I'r1;r'

 plc l{cta!l Pr;ec { n(lcx

is l]tethotl does llot talie lccoultt ol-thc thcl 1ll.i1 solne goods are nlol-c ill)PoTllrlll lll rrr
.ltc|s. BLtl a\cri!gc Jhnil\ sperds lal l orc of il-\ incolle on sonlc'itcrrs lhntl otl ollrtr
te )s. Ijor inslancc. the pr.ices o1'trcal \eget;rblcs liuits, eleotricitl, gas and thc c()ril ()l
/)ollsin!, ul.c fiu ntore irrpoltiutl than th,- prices oflrtxltrl goocls Sttcli as Luxtlt! cars ot llig.lr
l.shioi clotiring.'lhis pr.o6leur is sol'c-d ir the scconcl rrrcthod by giving ertch i1r:nr .
\\,cighl lo reprcsent its share irt thc total slcndllrP ol'tltc avclllS-c inrnilv'

(i) Numerical example-1 an explanation of Simple Retail Price Index to measure

the rate of inflation

I
I Nou,. the Ratc of inllation is equal lo ACI- ABI, thrt is,
120-100:20r'o.

t llxslllallll
) Thc year in rvhich index begirrs is knoun as the ba,rc lt'ar In out cxample Ycar I is the
I l
base -Ycar.
In thc basc year, cach pricc is given Lhe indcx laluc ol 100.
I ln oLrr exarlplc Year 2 is knorvn as currcDl vear' I't'ices ol'cach itenl arc cxpressed as
changes on the basis oi-100 For crarnplc the ltice ol colrnlodil)''A'lras rjsen lronl
l0pence to 12 pence, so, its index has risett lirtr 100 1o 120 The lonnula to gcl
t Liurrcnt 1-eal indcx of cach cotntriotiitY is cqrial to Current lear prlce ol given
commodity (Ul' of 'A') divided bl the Basc vear price ol tllat fr,ivcn comr.nodity (BP o1'
'A') and thcn rnultiplied by 100. that is, l2i l0* I 00 - I 20
I
i ln short form, current year index of each iteNrr=CF+BF*100

I / (l':9 ti.a NotL''1,

"lDS/'L.an.]].tit

I
:

I
 fltc pricc intlercs lirr tht' Llillilerl cotrttroditics in 1ll. bas!')crr arc' adclcd Log,rll
alcl clirjdecl by tlle nulnbcr ol cotnnroditic's se'lc'cted to gc1 Alcrage ]:la:;c \
Inclcx(ABI)
The price indexes fbr thc dillcreltt commodilics ill tlle curl ent ] eal at'e addcd logetl
ard dividcd b-v lhe nutlbcr of commodities selected 1o gct Average (lurrcnt l
Index(A('l )
Finally, the rate of lnfation = ACI ABl, n oLrr example 124 140'20'

(ii) Numcrical cxanple-2 and cxplanation of Weightcd tlelail Pricc indel to

rneasurc the rate of inflation'

Year t(B
I (E ase Ycar)
t I

Commodity ,u"'rn,
I
Pr-ice lIi
r

I
l
A
ls
100

Average Base Year lndex (AI3l) = 600 + 6 :100

Indcx
Index
(Weislit x

2x150-
3
I sqllsfltolrclrtcd Idcr : !q nrcrlselurrg ar
I
lndex (ACI) q9!-- 6 =l15
The Rat€ of in{!ation is cq ual to ,4Cl_Al}I, that is' I l5-100= 159/o

Il,e l(dlc ol ill{lrliun i. eqlr. I o .{aT \Tll.

thatis. ll5-100- 15%.

"'.ilr?E*.=

'DS/F..onaet)t / (jr9'r,con itat.5 '1s P,,g

 ,lanation.
'l lrc vcar in ulricli indc>; bcgins is knol'n lis llle f.r.!c l ..rr
n orrr cumple Ycar 1 ls lhe base lcar'
r ln thc btse ycar, each price is givel thc indcx valLlc ol l00
). tn our cxarnplc Year 2 is krou'n as currcnt )ei!r' Prices ol caclt iteiu arc expressed as
chaoges on thc basis of 100.
lirr cxarnple thc price of commoditl 'A' ltas risen lront 1 0pcnce 1o I 2 pencc' so' its illdcx
hus rjscn fron 100 to i20 (Re1er to t'r-tttucrical exatrtple gii'en bclouJ
l hc ftirrrula to gct Curcnt ) car index o l each cttninoditl is cclual to llun cnt ycar pricc of
givcn conmo<iit1'(CP of 'A,') divided b) 1he ilase -"-ear pricc of that givcn cornlnodjty (RP
ol 'A') and thcn multiplied by i00, that is, l2110* 100 ' 120
I in short form. Current \ear lnder ofeach itcn = CP IIPx 100

Differences betrveen simple XlI andllr'ctghrcdAlt

I n_wsjsh&d_B!1 mc1hod;
" Ilach comnodity is givcn a weight (a ccrtain nulnbcr) lo represent its sharc in thc
totai spending ofthe average lantilv.
e Pttce index of each commodity is multiplied by its u'eight given in order to get
Weighted index of each commodity. !or exanple, rveighted index of courmodity
I r
'A':1x120:120
Both Avcrage Base year index (AIll) and Average Cunent year Indcx (ACl) are
I lbund by dividing thc sum of price inderes o1'conmodilies sclected by the total
nunbcr of v'eights respccti\ elY.
c ln our cxan.rple, ABI:600 = 6:100 and ACI = 690 + 6 :115.
t Finally, the rate oJ inllqtion bv WeiehrqL!:r|c9!!t!!9.r 4419!l is eqLLal to:
s I ACI ABI,thatis,l15 100=15%

I C,AUSES OF

I
INI.'LATION

Demand Pull Inflation. 2. Closl Push Inflation.

I I Monetan lnllation. 4. In.rportcd Lrfl ation.

!f-9rqgryL!.!d.!-!nfiatiqn! .Once thc countr-v's rcsources are luliy emploved. when an

aggregate (Total) demanci cxceecis an aggregate ('ibLal) suppiy, there uill be an increasc in
q'il1 be dcscribed as l)emand Pull inflation
lleneral price lcvel and which

'iD,\,/f.eo O.?t / (jt:g f.cofl:1tot.r'15 I''ll('67

 ,asons for l)emtnd tr'ull inflation at full employment
. War lilne conditiotts, 2. i\4orc expons.
3. I'-conornic grou'tir- '1. lncrcasc itt govcrntlt'nt spc-nding-

War time conditions: War brings full eurploynent, a large incrcasc in total iltcome and so
an increase in aggregate deinand but the supply o{'goods and services t'all as rcsources are
used to produce military goods and sctvices instcad oi' consunrer goods. As a rcsult
gcncral prices rise leading to Dctnand -Pull inllation.

Morc exports: A country may try to produce goods to achieve exporl surplus, in order to
pay off some overseas dcbts by rcducing supply for domestic use. As a result, an cxcess
doncstic dernand over domcstic supply will cause Demand-Pull inflation.

Ilcononic gro*.th; can be achieled by produ,.'ing trorc cupital goods than consumer
goods. So, resourccs will be transferred liom the procluction of consumer goods to thc
production of capita) goods. It means an exccss demand lor consumer goods and serviges
over supply may lead to Detnand-Pull inflation.

Incrcase in qovernment spending: Another possible cause of Dentand-Pull inllation under

condition of full cmployment is an expansion ofgovernnent spending financed b1'
borrowing from the banking system. In this casc the expcnditure ofthe govemment is
financed by an increase in rloney supply.

<.\

a._roo much money chasing too few goods'- the main reason for demand pull inflation
i
f
'a.t/f,clflOept / 9r9E on:i'tdrs '1t P:rge 6
 Demand- Fui{ inflation dla ra i.r.! at ernpIovmenl

ADr
ADq

ADg

t lhc abovc diagram explains that shifi AD curve lront ADl to ADj rvill increase real
oLrtput (liom Y2 to Ys) but the pricc level will also risc (h-om Pr to P2). lhc result is
t sinrilar if AD rises to ADa. At this stage, the economy is approaching the flrll employment
lcvcl ofrcal outpul, so sone industries still have sorne spare capacity but othcrs rvill be at

I Iirll capacity, resulting in price rises in sorre industries, and so a rise in thc average price
lcvel when AD rises.

A [u l]er incrcase in AD whcn the ecolomy is at full enrployuicnt (AD level ADa) rvill
simply result in a pricc risc rvith no increase in thc ler,cl of real output. The diagrarr
shows that increases in the levcl of denrand in al1 econom)' causc inflation. Thc rising
(
lcvcl ofdemand is'pulling'the price levcl up, hence thc namc 'demancllull' inflation.

; (lost-Push trnflation: ,4.n incrcase in general price level cluring a period of time duc to
lll incrcasc thc prices of factors of production.(Costs of production)
I
i
t'trl/,t .ot.Dcpt I
/ Qt9ta.oa '15
t'c hrr
^in.s
 roduction:
ncrcasc Irl
. Rcnt.
. Wages,
. price of raw materials
o llrnk interest etc

Cost- Push inflation diaqram

('nd lirl
SRAST

><\ \SR S RAS

'
I
i
I __. \.
, '\. I

I
AD

I
'<- l
/a Y' ?**'-]
;^,.!

Thc above diagratn explains that a rise in cost of production shifts the supply^ cut
fSneS'ttu the"lcl-l (Slins2)and pu\hing. up llte gcneral pricc lercl liom Pr to P) A
rcsull output ll.o decrc.t.es fr.rm Y' to Y'

3. Imported inflation: An incrcasc in the prices of impofi goods and services can lea<
inflation in the country. As price of irnports increasc, prices of domestic goods us
imports as raw materials also increase. causitrg alt itrcrcase in thc general pricc levcl o{
the goods and services.

4. Monetarv inftation: According to Monetarist (grouP oleconomists) points ofview

incrcasc in supply oftloncy can t'aise the gcncral price level ofgoods and services in tl
country. Moncy supply ircrcases f.islcr than thc suppl;' of goods and sclviccs causiltg t
priccs to rise.

'AS/ q-tun lDept / gf, 9 tltLon 7lotet' I t I'r,

 .._il

iosts( ES'ects) of inflation

&rsiraqlS f!r!!r Rislng prices rcduce thc purchasirrg power (lieal incorire) of
:ople. For exarnplc, fixcd inccme group people like pcnsioners, salaried peoplc
,ufler liom lhc effect of inflation. But professional pcople, workers in a strong trade
union may not sulfer because ihey may succccci in raising their wages during
inflationary situation.

b. Savings and Lendinq:- People who save or lend rnay also be hufi by inflation. lf they
lind the inlcrest rate rcceived on money thcy have saved or lgnt is lower than the intlation
rale the real value oftheir monc,l rvill lirll. So, pcople who have lent (Creditors) lose while
those who borowed (Debtors) gain in the liile of inflation.

b Production/lnvcstment:- In dcmand-Pull inflation. increased spending by thc

consumers tcnds to boost company profits. So producers will try to increase their
invcstment. But in Cost-Push inflation companv prolits are squeezed and it may
tliscourage the producers to go ior investment,

c. Incomc digqibution: Inflation will result in greater inequaljty

in income distribution. The groups that \\,ill gain are varied
income group ofpeople likc business peoplc u'hile lixcd
income group ol peoplc like salaried people, pensioners wili
sulfer.

d. Extemal value ofmoney: If therc is a lall in the internal value

l olmoney due to inflation, the extemal va)ue olmoney also
will fall in terms of exchange rate. Other countries rvill find the
currcncy more expensive and hence there will be iess dcmand for
it and this wili lead to fall in the extemal value of money.

l c. Balance of pqy!0c!!!: Inflation may lead to unfavorable balance

1.
country.
t{igh rate of inliation may cause uncmpioyment in an economy.
of payment of a

t
Mrcro Econornie policies to deatr witLi4[la1l!q4
I L Br reducinc a!:prep.ate (Total)
When a govcrnment bclicves that inflation is being causcd by tht: excess
I demand, it wiii use one or more ofthe follorving demand side nreasures.
R. Cc'!!rq!listqL-!i!94l : By this method the govenxnent can try to control
I inflation by decreas ine -{}Lf1e]l!!i,!Jg-q!1!L.!LbLh!,!iLrggsi!E-!gJr!. This is becausc
thi: method will reduce tbe peoplc's demand (aggregate demand for goods ar'd
scrvices rvhich in turn will help to iower the gencral priccs Icvel in the economy.

' I \\'t t nn A.tt / 91 9 Ecafl- J,lotes-' 1 5

 ,. !rtOrlcl-a\Jtp|i!1: l'his cconrrrttic pi:'licr is rrclopted b) 1i)c ('enlrll
-!,t!1!1!-!!e111tr] -
Bank o1'l coulitry on bchalfol its go\,crrnrent 10 dcal \\i1h ittflation. I\'tlris
lrctli(xl the (lcntlal Llnrrk can lcducc thc nronel srrpplv rrhiclt is u carrsc iti
inllation b1 21rlirg !4\!!-!L!J!41.qtt_(1!!Jt!Jl!gALl-lllfu\ lqy|11g !1y 471;11113 rlt4rys1
ftLt' 4u4trlllll(I]4!- jpqL.lt!!1t4 zpelqt U!! that is. b1 sclling so\cronrenr
bond-s( securit ies ) on the opcn rrarkct.

c. Il!11e:lUf{lC1ctrql!qt!!!: B1, raising the ntinirnunr dcposil and reducilg the tirne
lllowcd lbr rcpavment, aggrcgate denrand lbr gootls antl serviccs can be rcdLtccd
rvhjch in turn help to lorr'cr lhc gereral priccs levcl in thc econonry.

2.'lncreasinit agqretrate supDlt (Supph side policics): Incrcase in supplv ol-goods and
scrviccs in one rray of overcorrring exc:ess dcmand. (l-o deal u.ith inllation) [his rnal be
dil'trcult in thc. short rtrn. but thc governurenl could help to increasc the elllcicn$' 01'
industrics in scveral wa1s.
By irnproving thc traiDing and re'-traitring ol'labour k) trake lubour rrorc rnohilc,
"/ Ily providing gr.anls to cncouragc ir]vcstrnent in more lrp 1(' date !'quiprncr)r,
l/ y' lly promoting horizontal integration rvhere it tould lcad to cconorries ol scalc, and
/ py canying out improlerDents in the transpon and comrnunication net works.
3. Incorne Loliptgl: An inconre policy
is an Nttcmpt of it government to deal wirh inflation
by slowing dorrn the rate at u'hich costs ofproduction such as r',agcs. intcrest, and rcnt are
rising.'fhis income policy c.in be a yolunlar) policl'oI a legal linrit policy. lJ) voluntary
incornc policy, the govcrnmcnt may appeal to the trade urions and nther olganization not
to press for incrcase in rvagcs during inflation. l1'thrs policv lails, thc governrncnt rvill
p)ace a legal limit orr the incorre increasc.

4. !119e -Qontrols: 1 o control inflation, tlrc govcmn'lcnts have t.he powcr to control priccs.
Eg: Maximum price (pricc ceiling) imposed by govcnurclrt, s hich is sct belorv the
equilibrium or rnarket price.

t- lnflatio!t ->

<E Bef lation

'a).t/'1 n.Dtrt / (ir9't:a,':Itl,l.s t5 PaSe;.

 I)cfla(ion is a periori of pcrsistent lall jn the getteral prici , t/ W i,r
,u .'*"r-") cluling a given pcriocl oftirrr.'. llcilatiort ,r..-) .',,.,, .,,. ,',,,-',.,,, , ',.. ..,ttt
belou' 07o (a regalirc inilalion rlilc). lhis will calrsc Lhe ';alrrc of nlotre\ lnd purchasillg
porrcl or rcal income to incrcasc. I1 irlso mlkcs the cost ol a blsket ol gotl<ls attd setlices
less erpensilc.

cAUSlls () l.' l)EI.-L,A'II()N

Posilire dcflation: l his kirrd of clcllation arises duc lo incrcase in aggregate supply ot
incrcase in productivc potcntial ol the cconoml utich.cttLtscs thc pricc Icvcl ol-[oods and
,rl serviccs to lall. Il'priccs ol goods are falling bccause ol'rnajor tcchnological adrallces or
rnassivc improvemcnts in the prodtrclivitr- of labour, then deliation cottld be considered a
sign o1' healthy grou'th.

Effects of Positive Dcflation:

i Fall in price lcvcl: As a rcsLtlt oi inocase in aggleg.atc supplv, tlorc goods attd
I services u,ill bc availabic in the ccononry r,vhich in tunr rcduces the pricc lcvcl in
the econorny.
I ! Incrcasc irr Employmcnt: Fall in price lclel increases thc dcmand tirr goods and
sen'ices and ircreased laboul plodLrctit'ity incrcases (he dcmand fbr labour'. 'fhcsc

I t\\'o in lurn increase the detriutd for labour that gcllclates nlorc errplo)'l)rcnt
opportunitics.

ll > lnprovemtnt in Balanct of pa) mcnts Position: Wllen pricc Icvc'l decrcasc's,
cornpctitir.eress of tlre couutrl's products in tbe lbreign ularkcts \\'ill incteasc as I
rcsult exports ir-tcrertses. A1 1hc same time due to highcr prtrdLlclion. lnorc goocls and
thc'

services arc available in thc country at a lorv pricc u'hish rcduccs ttrc dcmand fbr
t imports. A lise in erports and lirll in irnports u'ill inqrrole the status ol lriLde
balance in the econ0ln).
! Incrcasc in llconomic (iro*lh: lncre'ased labour ploch:ctivit)' and technological
fi adlancerncnt alorg rvith incrcased lggrcgate dcmand llottr consu]ncr s1-.cnding,
invcstnrent l)) tlrrns aod inclcasc-d cxporls *ill increase lilc natitual oLlqrut and
l, cconOmic gro\\{h in th(] counlr ) .

Ncgatilc Deflation: lhis kind o1'clt-llatiotr arises dtte lo fali in aggregatc dema$d in rtn
h cconom-y during reccssion and dcprcssion. I1'tlle ttlll iri plicc is causetl bv rt dcclinc in
ripcnding in thc ccolloul). thc c(rnscqucnces cau bc velr. tracl. I incrnplo) rucltl \! iil iltcrcitse
lr
t'tr.l,/,Iarct 9)ctt
/ Cr')'l ra'N.t. s' I 5 f itr T:l
 r.c()n()Dl\ \\'ilsc lirlc. irtr.slntcnt. (il)i'. l:cononlic glo\\'lh \\ill decrcii:c.
u h!-rr'as
c\Pcctaliorl ol lirtrilc dellation caD ltrt'c' as r'!jtrlll\ clc\ nstating cjle(t. Il pcoplc expcrt
Lrre clcllation thcn tlrt'r uill ncrt spend Iton bttt slrc llte nlor1c\ sincc thct c\ircct tlleir
.uchasing porvcr to rise.

Effccts of Necative Detlalion: Czv"ss Ja,"e;le Wo l-c\

, Rising Unemplorment: Decreascd dcutancl lor goods antl scrlrccs rncrcascs
uncnrplol'mcnt: as conlpilnies necd to cut cos1, tltey necd kl lire cmplolces. who are
not producing (because the,v don't have any uork to do).
lligher gol'ernmcnt dcficits: as rnost costs stil)- the samc, and somc expenditures
increase (eg.: rising uncmplolmcrt aid pa),tter1ts, cost of iumpstafiing thc
cconomy) aiong *ith decrcase in iax rclentte thc (;o\.crtment dcflcit u ill increasc.
t'all in Economic growth and chince ofReccssion: When denrand for goods ancl
scrvices dccrcases and ulemplo)merrt incr!-ascs, it results in lall in economic
activity or recession. This in tum rcduces (jDP and ends with negatile econonic
gro\\'tl1
Nlore expcnsive imporls: same lbrcigrt cutrencf is \\,orth nrole in dorncslic
I (urrflr(y (r5 il rcslllL inlnolls hcc,'lnc crpclt.irc.
r i\fore income from exports: sanc tbreign currcncv is wonh mu.e in donrestic
currency as a resutt exporls becomc chcaper and its demand incrcases.

MI|ASUIIES TO OVERCON'IIi I)1]FLA'TION

In ordcr to ovcrcorlle the of

rtegatir.'c' deflation. govcrnmcnt can use thc
problerns
cxpansionary demand sidc' policies rvhich \\ill
bot)st the aggrcgate dcmand in thc
economy.

'r lJxpansionary !'iscal Policv: Ry rcducing taxes irnd incrcasing its spending,
govcrnmcnt tries to incrcase the houschold spending and investmcnt b1'the firms in
the econorry. As a lesult, tll!'101al dclnand ibr goods artd scrvices in the economv
r.r,ill increase-
frinting more Money: To increase the alailability ol
money with people
governmenl will print and circulatc more cun€nc) in thc economl. I'his u'ill boost
tlre pcople's consurnption spending and as a resull aggregate demand u'ill increrse.
lixpansionary monctary policy: 131 Ieducittg intetesl rates. illcrcirsiltl l)ank
lcnding, etc, central bank crlcourages thc spending and discouragcs thc saving
mentality ol'peoplc. Moreover finns u iil bc read,v ro ir)\,csl rnorc as thc interest ratc
-l'hese
{bl loans decreascs. tu,o in tutrt incteascs t}}e tggrcgate dctt;aiid in the
econom)'.

'a.t/,ji.k f, frtt / Or 9 q[oa :t(ot.s' 1, l'aAe 7i