29 January 2025 : Daily Answer Writing
Q1) What are the various factors that influence the inflation trends in the country? Highlighting the role played by the Monetary Policy Committee (MPC) to check inflation and promote the economic stability and growth prospects in the country. (150 Words/10 Marks)
Answer:
Inflation refers to a broad rise in the prices of goods and services across the economy over time, eroding purchasing power for both consumers and businesses.
Factors influencing inflation trends in the country:
1. Increase in demand for goods/services, exceeding the availability to meet those demands leading to a rise in prices. E.g., Real estate prices go up due to less supply and more demand.
2. Conversely, a decrease in the supply of goods and services in an economy can cause inflation because there are not enough goods and services to meet the demand.
3. Monetary policy: lower interest rates by Central bank – more money supply in economy;
4. Fiscal Policy: Government taxation and spending policies can impact overall demand in the economy, affecting inflation. E.g., high government spending causes inflationary trends.
5. Other factors: (a) availability of labor, unemployment rates, and labor market regulations; (b) Disruptions in supply chains; (c) weaker domestic currency can make imports more expensive, leading to higher overall price levels; (d) Changes in the prices of key commodities like oil, food, and metals on the global market.
Role played by MPC in the country’s economic stability and growth prospects:
The main aim of monetary policy is to keep prices stable, manage inflation or unemployment, and keep currency exchange rates stable while achieving the goal of growth.
1. MPC sets benchmark interest rates (e.g., repo rate) to influence borrowing and lending rates in the economy.
2. Low and stable inflation – has been able to control effects of many populist policy of government before elections to provide a short-term boost to growth that leads to long term inflation
3. Ensure adequate flow of money and credit to required areas of development.
4. Prevent sudden depreciation and appreciation of currency + protect rupee valuation from global economic shocks. [ex: Lira had depreciated over 80% against the dollar in the last 12 months. This has not happened in India]
5. Sustainable investments – MPC has boosted the investors’ confidence this has enhanced credit ratings which have led to more investment
However, MPC also faces certain issues like:
1. Flawed model of Inflation Targeting – the MPC works on the assumption that – increased output is greater than natural level output, this is not statistically validated – has lead to setting policy rates based on unscientific assumptions.
2. Exclusive focus on inflation has slowed down growth – inflation management has negatively impacted GDP growth – ex: since 2016, steady increase in repo rate and a steady decline in GDP growth
3. Inflation is global in nature since price level of a good is determined by millions of producers across the world – solely targeting inflation is not good for the economy
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