Friday, April 10, 2009

INFLATION RATE IS AT 30 YEAR LOW - WHAT DOES THIS MEAN FOR YOU AND ME?


Yesterday, the inflation numbers came in at 0.26 as against 0.31 a week ago. This is the lowest rate of inflation in India in last 30 years.Is this a reason to rejoice or regret?What exactly does low inflation mean to a layman. How does this impact our lives and should we really be worried about it? We will try and find out answers to some of these questions here.

What exactly is inflation?As per wikipedia ,inflation is a rise in the general level of prices of goods and services in an economy over a period of time.Simply put it is the rate at which the general prices of goods and services are increasing over the last year prices of the same goods and services. Higher inflation denotes increase in the prices at higher rate while lower inflation means that the prices are rising at a much lower pace. Low inflation does not mean that the prices are decreasing.
Does it represent all the goods and services? Inflation numbers represent the fall in wholesale prices of goods and services comprising the wholesale price index or WPI. It does not represent the price rise of goods and services comprising the Consumer Price Index or CPI. As a consumer CPI index is more relevant for us since most of the goods and services that we use are represented in CPI.So in effect , the inflation numbers does not truly reflect the ground realities from a normal consumers point of view.
Does low inflation mean Lower prices for goods and services? No. Low inflation only means that the rate of price rise has come down. The prices are still rising as compared to the prices last year.So inflation rate of 0.26 means that the prices of goods and services comprising the WPI has gone up by 0.26% as compared to last year. It does not mean that the prices of goods and services have come down for us. For that to happen we need deflation.
Low inflation is good news because:-

It allows RBI to push for lower interest rate regime - Lower inflation numbers indicate that either the demand for goods and services are not rising as much as one would like or there is liquidity crunch in the economy. Both ways, RBI will need to correct the situation by increasing liquidity in the economy. To increase demand , RBI will lower the benchmark lending rates making loans cheaper for common borrowers like you and me. So low inflation helps us by making our mortgage loan, HL, Personal loan , car loan etc cheaper. The trick is when we get to such a situation try and take a loan at fixed rate and not at floating rate so that when the inflation rate goes up , you will still have the loans at lower rate.

- Real interest income on your deposit increases - Do you know whats the real rate of return you are getting on your deposits like FD, PPF, NSC etc? Real rate of return is the rate of return in excess of the inflation rate. So, if your FD rate is 9% and the rate of inflation is 7% , then your real rate of return is 2% only. Similarly , if the inflation rate goes up to 10% your real rate of return on your FD will be negative -1%. So in effect you will be loosing money. That is why high inflation scenario is bad. On the contrary , lower inflation means that your effective returns from your investments go up and that is a great news for all investors.

- Less slide in the purchasing power of the money- Lower inflation number also means that the purchasing power of money is not sliding away rapidly which is the case with higher inflation. So it protects the purchasing power of the currency.
Low inflation presents case for prepayment of loans - When the inflation rate goes down , it means that the value of money is decreasing at slower pace and hence for all those borrowers who have loans to be repaid in future , the money outflow in real terms will be higher. That is because , its assumed that future value of money will be reduced to the extent of inflation and if the inflation is less the value of money will be more. So to counter that , if you can afford to prepay your loan , you must do so.
Which is better - High inflation or low inflation?Low inflation is always better than high inflation since it keeps the economy in good shape. The productive forces in the economy keep working well and the purchasing power of money too doesn't recede too fast.Ideally, Central Banks
world over aim for a situation of low inflation and high growth in the economy , but, seldom do they manage to achieve both for a long period of time because higher growth means more money in the economy fuelling greater demand for goods and services resulting in higher inflation .

10 comments:

  1. I have heard from some money talk shows that once the economy picks up and recovers, then inflation will be at an all-time high; a rate that will make Jimmy Carter's term as presidency look like cakewalk. What is your view?

    ReplyDelete
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  3. Hi Amy P
    I also think that with all the money being printed out of thin air by the governments all over the world to bailout various companies , will lead to a situation of high inflation in future .

    ReplyDelete
  4. Hello Rajeev saab,

    Good and very informative post. It shows your sound economical background. As you said, there will high inflation when the economy picks up. But government will have work with fed's to tackle the situation as they always to do to implement fiscal or monentary policy to smooth it out. But you are sure to see high inflation for a bit and go away.

    Inflation is good for the economy but hyper inflation or stagflation is not good.

    I love to get in touch with you. I don't see any of your contact info. Please contact me at tmvijai at gmail dot com if you get a chance.

    Thanks
    VIJAI

    ReplyDelete
  5. Hello Rajeev saab,

    Good and very informative post. It shows your sound economical background. As you said, there will high inflation when the economy picks up. But government will have work with fed's to tackle the situation as they always to do to implement fiscal or monentary policy to smooth it out. But you are sure to see high inflation for a bit and go away.

    Inflation is good for the economy but hyper inflation or stagflation is not good.

    I love to get in touch with you. I don't see any of your contact info. Please contact me at tmvijai at gmail dot com if you get a chance.

    Thanks
    VIJAI
    moneyreallymatters.com

    ReplyDelete
  6. Hi Vijai

    I am really glad that you liked my post..You may contact me at rajeevsingh111@yahoo.com

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