Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate.When Prices rise the Value of Money falls.
1. Demand Pull Inflation
2. Cost Push Inflation
Causes for Increase in Demand :-
g)Increase in Income
i)Increase in Black money
j) Increase in Credit facilities
Causes for Increase in Cost :-
10.Effect on value of Money
11.Effect on Investment
12. Effect on savings
These factors include - money supply, interest rates and the inflation. In banking and economic terms money supply is referred to as M3 - which indicates the level (stock) of legal currency in the economy.
Besides, the RBI also announces norms for the banking and financial sector and the institutions which are governed by it.
Stability for the national currency (after looking at prevailing economic conditions), growth in employment and income are also looked into. The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short-term implications.
It is the interest rate which is fixed by the RBI to control the lending capacity of Commercial banks . During Inflation , RBI increases the bank rate of interest due to which borrowing power of commercial banks reduces which thereby reduces the supply of money or credit in the economy .When Money supply Reduces it reduces the purchasing power and thereby curtailing Consumption and lowering Prices.
CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. During Inflation RBI increases the CRR due to which commercial banks have to keep a greater portion of their deposits with the RBI . This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation.
Banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements . If SLR increases the lending capacity of commercial banks decreases thereby regulating the supply of money in the economy.
It refers to the buying and selling of Govt. securities in the open market . During inflation RBI sells securities in the open market which leads to transfer of money to RBI.Thus money supply is controlled in the economy.
This will reduce the supply of money in the economy.