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Manipulation Theory of Inflation: A Research Study on Components of
General Price Rise
Article in PRAGATI Journal of Indian Economy · November 2014
DOI: 10.17492/pragati.v1i2.2507
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Manipulation Theory of Inflation: A Research Study on Components of
General Price Rise
Arjun. Y. Pangannavar*
ABSTRACT
In general, inflationary situation arises when aggregate demand increases more
than aggregate supply. The imbalance between these market forces are caused by
several monetary and non-monetary factors. This is what we all know about theoretical
frame work of the concept ‘inflation’ but the practical aspects of inflation are different.
The present ‘world inflation situation’ is quite different from the past one; despite
various efforts by government through economic policy, the inflationary situation has
grown worse. In this context, it is necessary to find out the causes for mounting inflation
rate making all anti-inflationary measures ineffective. There is a need to realise the fact
that whether inflation is a myth i.e. the saga of historical events like war-inflation, costpush and demand-pull inflation, monetary-inflation, tax-induced inflation, etc. or a
miracle i.e. the manipulation of policy makers, and market big-bulls. This is the
contention of my theory: Manipulation theory of inflation. This paper focuses on some
select factors and their contribution to inflation and also suggests some measures to be
incorporated in the government’s economic policies to deal with it. Besides, I intend to
make my research work of societal relevance.
Keywords: Inflation rate, Manipulation theory of inflation, Supply side analysis, Price
inflation, Market Big Bulls.
1.0. Introduction
Inflation is generally defined as the economic situation where general price level
rises continuously without an accompanying rise in production of goods and services.
This situation arises when aggregate demand increases more than aggregate supply. The
imbalance between these market forces are caused by several monetary and nonmonetary factors. This is what we all know about theoretical frame work of the concept
___________________
Associate Professor, JSS Arts, Science and Commerce College, Gokak, Karnataka.
Manipulation Theory of Inflation
„inflation‟ but the practical aspects of inflation are different. Hence, this paper has
concentrated on some select factors‟ contribution to inflation and possible measures to
be incorporated in the economic policies of the government (such as fiscal policy and
monetary policy) to control it effectively.
1.1 Importance of the study
There is need for to realise the fact that whether inflation is a myth i.e. the saga of
historical events like war-inflation, cost-push and demand-pull inflation, monetaryinflation, tax-induced inflation, etc. or a miracle i.e. the manipulation being played by
policy makers, policy-dictators and market big-bulls. Inflation has become a common
feature of a modern economy, whether developed or underdeveloped, rich or poor,
capitalist or socialist (or communist), In this paper, my focus is on finding the common
facts and causes behind the problem of inflation. The work could facilitate policy makers
in devising anti-inflation measures.Besides, I intend to make my research work of
societal relevance.
2.0 Statement of Problem
Inflation always remains a major detrimental factor to economic progress of an
individual as well as a nation. While it is not possible and desirable to wipe out inflation
completely, there is a need to find out the real causes and devise proper policy-measures
to control it effectively; prevention being better than cure.
2.1 Objectives of the study
This research study focuses on (i) identifying the causes of inflation, (ii) finding the
components of inflation rate and (iii) suggesting appropriate policy measures to control
inflation based on research findings.
3.0. Review of Literature
There is a large amount of research on inflation but much of it is on theories of
inflation-causes, measurement, effects and control.
3.1 Theoretical framework on causes of inflation
Adam Smith (1776) distinguished between nominal price and real price as “the real
price of everything…is the toil and trouble of acquiring it. The same real price is always
of the same value; but on account of the variations in the value of gold and silver, the
same nominal price is sometimes of very different values.” Inflation is associated with
nominal price. Bryan (1997) advocated that the era of inflation‟ began with the era of
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68 PRAGATI: Journal of Indian Economy, Vol. 1, Issue 2
issue of currency; “the era between the mid-1830s and the Civil War saw a proliferation
of banks; along with these institutions came „bank notes‟, a private paper currency
redeemable for a specific amount of metal”. It is during this period that the word
„inflation‟ begins to emerge in the literature, not in reference to something that happens
to prices, but as something that happens to a paper currency. Inflation has also been
defined as the process of making addition to currencies not based on a commensurate
increase in the production of goods [Jean-Claude Trichet (2004)]. The contention in
these definitions is that inflation is purely a monetary phenomenon and excess supply of
money-currencies and bank money, not based on production of goods and services is the
cause of inflation.
Historically, a great deal of economic literature was concerned with the question of
what causes inflation and what effect it has. There were different schools of thought as to
the causes of inflation. Generally they are divided into two broad theories viz. (i) Quality
Theories of Inflation and (ii) Quantity Theories of Inflation. The quality theory of
inflation rests on the expectation of a seller accepting currency to be able to exchange
that currency at a later time for goods that are desirable as a buyer. The „quantity theory
of inflation‟ rests on the quantity equation of money that relates the money supply, its
velocity, and the nominal value of exchanges. Adam Smith and David Hume proposed a
quantity theory of inflation for money, and a quality theory of inflation for production.
However, most the modern economists today use the term „inflation‟ as a continuous
rise in the general price level over period of time. Economists generally agree that in the
long run, inflation is caused by increases in the money supply. Monetarists have belief
that the excess supply of money is the case of inflation but it is refuted by the nonmonetarist. In a footnote to his speech, Bernanke noted that "people know that inflation
erodes the real value of the government's debt and, therefore, that it is in the interest of
the government to create some inflation". These arguments support the belief that
Central Bank plays the main role in inflation-issue.
Keynesians did not accept the monetarist argument but propose that changes in
money supply do not directly affect prices. According to Gordon (1988), there are three
major types of inflation: (i) Demand-pull inflation: caused by increases in aggregate
demand due to increased private and government spending, etc. (ii) Cost-push inflation:
also called "supply shock inflation," which is caused by a drop in aggregate supply
(potential output). This may be due to natural disasters, or increased prices of inputs
thereby increased general price level and (iii) Built-in inflation: induced by adaptive
expectations and is often linked to the „price/wage spiral‟. It involves workers trying to
keep their wages up with prices that results into increased cost of production and further
it results into a 'vicious circle of inflation'. Demand-pull theory states that inflation
Manipulation Theory of Inflation
accelerates when aggregate demand increases beyond the ability of the economy to
produce potential output. Hence, any factor that increases aggregate demand can cause
inflation. However, in the long run, aggregate demand can be held above productive
capacity only by increasing the quantity of money in circulation faster than the real
growth rate of the economy.
Thus it can be seen that while Monetary economists believe that the link between
inflation and supply of money is very strong, the Keynesian economists, by contrast,
typically emphasise the role of aggregate demand in the economy in determining
inflation; for Keynesians, the money supply is only one determinant of aggregate
demand. The implications and reconciliation of Monetarist and Keynesian thoughts on
causes of inflation is illustrated in the following figure-1.
Figure 1: Reconciliation of Monetarist and Keynesian thoughts on causes of
inflation
(a)Monetarist
(b)Keynesians
Y
Y
P=f(M,V)
Price
AS= Y=C+S
C+I+G
F
AD”
P”
K
Inflation
P‟
E
P
O
M M‟ M”
Supply of Money
AD‟
AD
S
X
O
Q Q‟
Income/ Output
X
Source: Drawn on basis of Monetarist and Keynesian ideology
Figure 1 (a) explains the Monetarists‟ thought that price level moves upwards
from P to P‟ and P” as supply of money increases from M to M‟ and M” that indicates
the happening of inflation in the free capitalist economy; Figure-1(b) explains the
Keynesian thought that when the total expenditure (C+I+G) or aggregate demand
increases from AD to AD‟ and AD”, the total output initially increases from Q to Q‟
before full-employment equilibrium level i.e. Q‟F, but above that level an increase in
aggregate demand i.e. AD” leads to inflation i.e. KE; the aggregate demand represents
the supply of money in the economy.
When we go through the literature on causes of inflation, we find a series of factors
responsible for inflation on both demand-side and supply-side, both money and
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70 PRAGATI: Journal of Indian Economy, Vol. 1, Issue 2
production. Once the price rise sets in, it turns into vicious circle of inflation both on
demand-side and supply-side (Figure 2).
Figure 2: Vicious Circle of Inflation
Demand-side
Supply-side
Inflation.
Price Rise
Inflation.
Increase in
Demand for Money
Price-Rise
Increase in Supply of Money
Rise in price of Inputs
Increase in Cost
Source: Drawn on basis of Monetarist and Keynesian ideology
On supply side, the initial rise in general price level raises the price of all types of
inputs that raises the cost of production which reflects on general price level thus entails
the inflation. Similarly, on demand side the initial rise in price reduces the purchasing
power of money thus more money is required. On the other hand, rise in profits and
returns raises the demand for money which leads to increase in supply of money through
credit creation and deficit-financing and government spending that further leads to rise in
general price level thus causing inflation. This process of price rise continues from shortrun to long-run where the contentions of classical, monetarist and Keynesians holds
good.
Further, in case of production aspect the shortage in supply of goods and services
to demand or excess demand over available supply is the cause of inflation, it is being
called „Price Inflation; such imbalance in demand and supply is being created by factors
such as wars, draughts, population growth, multiple uses, cost of production,
inducements like wage, profit, etc. In case of money aspect the excess supply of moneylegal tender money and bank money to the actual demand- purchasing power required
against available goods and services at current price over a period of time or excess
demand for money over available supply is the cause of inflation, it is being called
„monetary Inflation‟; such imbalance in demand and supply is being created by factors
such as business-conditions, high velocity of circulation, monetization of economy,
speculation activities, preference of liquidity, value of money, inducements like returns
of investment, profit, etc. Besides, there could be some forces other than demand and
supply that may be causing inflation that is the focus of this study.
Manipulation Theory of Inflation
3.2 Measurement of Inflation
In practice, the various indices being used to measure inflation rate differ from
country to country and amongst economic institutions. Consumers Price Index (CPI) is
one of the most common indices; calculated as the annual percentage rate inflation in the
CPI over the course of time is: P1-P0/P0 x 100. Wholesale Price Index (WPI) or Producer
Price Index (PPI) is another index of measuring inflation. PPI measures the pressure
being put on producers by the costs of their raw materials. This could be „passed on‟ to
consumers, or it could be absorbed by profits, or offset by increasing productivity. PPI is
different from CPI because PPI consists of price subsidisation, profits, and taxes which
are being availed by producers. Core Price Index is another inflation-measure which is
mainly used by central banks to measure the inflationary impact of current monetary
policy. It measure long-run trend in price levels. While constructing core price index, we
exclude such commodities whose demand and supply conditions change very quickly for
example, food, oil, etc. Gross Domestic Product GDP Deflator is also used as a measure
of the price of all the goods and services included in gross domestic product (GDP).
GDP Deflator is calculated as its nominal GDP measure divided by its real GDP
measure.
The above discussed inflation measures fail to include the price of assets which too
have impact on general price level. Some central bankers have suggested that it would be
better to aim at stabilising a wider general price level inflation measure that includes
some asset prices, instead of stabilising CPI or core inflation only. Asset Price Inflation
takes into account an undue increase in the prices of real or financial assets, such as
stock (equity) and real estate. The reason is that by raising interest rates when stock
prices or real estate prices rise, and lowering them when these asset prices fall, central
banks might be more successful in avoiding bubbles and crashes in asset prices.
There are certain problems with construction of price-indices such as selection of
base-year, selection of commodity, change in quality of commodities, disappearing of
old commodities and appearing of new goods, change in consumption pattern and
production pattern, change in technologies, change in life style, etc. Under such
circumstances it is difficult to measure inflation accurately. So there is need for
construction of General Inflation Index to measure the cause and effect of inflation that
could enable both central bank and government to devise suitable policy-measures to
control inflation.
3.3 Control of inflation
„Prevention is better than cure‟ must be the guiding principle of monetary and fiscal
authorities to prevent and control inflation. In practice, there are monetary and non-
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monetary methods to control inflation. Classical economists suggested „Neutral Money
policy‟ to maintain price stability in the economy. It means there is a need for
maintaining the balance between total supply of production- goods and services, and
supply of money. Most of the countries, both developed and developing/underdeveloped countries, have been practicing economic growth method clubbed with fiscal
measures and either „Dear Money Policy‟ or „Cheap Money Policy‟. If economic growth
matches the growth of the money supply, inflation should not occur when all else is
equal. A large variety of factors can affect the rate of both. For example, investment in
market production, infrastructure, education, and preventative health care can all grow an
economy in greater amounts than the investment spending.
The primary tool for controlling inflation is monetary policy. Most central banks are
controlling inflation through their monetary policy-measures such as Higher Bank-Rate,
Higher Cash Reserve Ratio (CCR) and Open Market Operations-selling government
bonds and securities, converting short-run bonds and securities into long-run. In India
Reserve Bank of India (RBI) has raised Repo and Reverse Repo rates to control
inflation. The „dear money‟ policy is being used to control inflation. High interest rates
and slow growth of the money supply are the traditional ways through which central
banks fight or prevent inflation, though they have different approaches. Monetarists
emphasise keeping the growth rate of money steady, and using monetary policy to
control inflation through increasing interest rates, slowing the rise in the money supply.
Since Keynesians have the belief that the excess aggregate expenditure (C+I+G) or
aggregate demand over available output is the sole cause for inflation they emphasize on
reducing aggregate demand during economic expansions to keep price stable. Control of
aggregate demand can be achieved by using both monetary policy and fiscal policyincreased taxation or reduced government spending, to control inflation.
Foreign Exchange Rate also plays crucial role in inflation. Fixed Exchange Rate
System was followed to maintain external equilibrium; the countries under gold standard
were following golden rule of gold standard, the supply of money was linked with inflow
and out flow of gold; an invisible hand was maintaining price stability. A fixed exchange
rate is usually used to stabilize the value of a currency, vis-a-vis the currency it is pegged
to. It can also be used as a means to control inflation. In addition, a fixed exchange rate
prevents a government from using domestic monetary policy in order to achieve
macroeconomic stability. During 1940s, under the Bretton Woods Agreement, most
countries around the world had currencies that were fixed to the US dollar. This had
reduced inflation in those countries, but it had also exposed them to the danger of
speculative attacks. After the Bretton Woods Agreement broke down in the early 1970s,
countries gradually turned to Floating Exchange Rates. However, in the later part of the
Manipulation Theory of Inflation
20th century, some countries reverted to a fixed exchange rate as part of an attempt to
control inflation. This policy of using a fixed exchange rate to control inflation was used
in many countries in South America in the later part of the 20th century e.g. Argentina
(1991–2002), Bolivia, Brazil, and Chile.
Wage Policy and Price Policy are other methods to control inflation. Wage and price
controls are successful in wartime environments in combination with rationing.
However, their use in other contexts has mixed results. In general, wage and price
controls are regarded as a temporary and exceptional measure, only effective when
coupled with policies designed to reduce the underlying causes of inflation during the
wage and price control regime.
These policy-measures have been devised on the basis of the factors causing
inflation in the economy but sometimes they are not very effective in controlling
inflation. In the present context, countries like India have been facing persistent inflation
which is detrimental to their process of economic development. Through this study, we
try to identify the major components of inflation to cure it in budding stage.
4.0 Methodology
The study is based on both primary and secondary data. Simple tables,
construction of indices, share-percentage and multiple correlation coefficient methods
are used wherever necessary to analyse the results based on findings. The period taken
for study of price-rise and its components is from 2001 to 2011.
Some of the limitations of the study are: (i) It has focused more on supply-side
factors; (ii) only twelve items are selected for construction of inflation index and (iii)
direct interview and observation methods are used to collect primary data.
5.0 Result Analysis
The main objectives of this research-work are (i) to identify real causes of inflation,
(ii) components of inflation and (iii) suggesting appropriate policy measures to control
inflation based on research findings. The nature of inflation is the same throughout the
globe, though there are changes in policy, consumption and production patterns. I have
designed a new method to measure inflation called „Price Index Components
Contribution Method to Measure Inflation‟. Unlike traditional price index, I have used
major factors as components of inflation which cause as well as impact factors of
inflation. It involves consumers, producers and government involvement in construction
of index called „Inflation Index‟ Usual average, percentage, inflation rate, price-index
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74 PRAGATI: Journal of Indian Economy, Vol. 1, Issue 2
methods are used to assess the results and findings. To construct the inflation index, I
have selected 12 items which included consumer goods, producers-goods and assets.
They are: (i) meal, (ii)cloth, (iii) electricity ( these are consumer items), (iv) land, (v)
gold (assets), (vi) higher education, (vii) medical expenditure- health-care, (human
resource development), (viii) diesel, (ix) wages, (x) cement (producers‟ items), (xi)
taxation and (xii) deficit finance (Government Measures). The data related to these
items are collected by interviews, discussion with experts, publications and government
reports. The rise in price or value or amount of these items are the effect of general rise
in price that further leads to further rise in general price level; it constitutes the „Vicious
Circle of Inflation‟ But the rise in price or value or amount of these inflation-components
or items may be declining or increasing; if rising, it indicates the active role in cause for
inflation or if declining, it indicates less active or passive role in cause for inflation. I
have selected 2001 as base year and 2011 is taken as current or study year. I have
constructed „Price Index Components Contribution Method‟ (PICCM) to measure
inflation. PICCM Method and the share of each component in inflation are explained in
Table 1.
Selection of items: We may take items in any number that is convenient to construct
inflation index but they should represent the rise in general price level. To construct the
inflation index I have selected 12 items as mentioned above. Since it comprises the items
representing the contribution of consumer goods, producer goods, assets and government
finance, it is a more suitable index to measure inflation. Hence it more appropriate index
comparatively with the existing methods. The price or value or amount is related to per
head or per capita.
Price: Price per unit is take for items like meal, cloth, electricity, land, diesel, cement,
wage and gold but in case of higher education expenditure, and medical expenditure are
calculated as total expenditure in a year divided by total number of actual days; deficit
finance and tax-burden are calculated as total amount in a year divided by total
population of the country. While using price of goods and assets the average of twelve
months is taken into account. Since general price is function of all these items, it is
necessary to construct such inflation index to measure the contribution of each item in
rise in general price level.
Price-Index (PI): Individual item index is constructed by using the formula: PI = P1/P0x
100, P1 stands for study or current year price and P0 stands for price of base year that
helps compare change in price of value of item or variable in question. Base year need
not necessarily be normal year because the base year should be selected according to the
need of research study.
Manipulation Theory of Inflation
Table 1: Price Index Components Contribution Method to Measure Inflation
Item
Per Meal
Per Mtr Cloth
Per Unit
Electricity
Per Sq Ft
Land
Per Day Exp
on Higher
Education
Per Day
Medical Exp
Per Ltr Diesel
Per Kg
Cement
Per Day Wage
Per Gm Gold
Per Head
Deficit
Finance
Per Head Tax
Burden
Total=N=12
Base Year 2001
Price
Index
(Rs)
(PI)
P1/P0X100
Contribution
Ratio
(CR)=PI/∑PI
Share:
C/1 x
IR
(%)
0.0833
0.0833
0.0833
Current year 2011
Price Index (PI) Contribution
(Rs)
P1/P0X100 Ratio
(CR)=
PI/∑PI
65
185.71
0.048
150
214.29
0.056
2.55
463.64
0.120
35
70
0.55
100
100
100
70
100
0.0833
415
592.86
0.154
3.399
75
100
0.0833
350
466.67
0.121
2.670
15
100
0.0833
35
233.33
0.061
1.346
12
5
100
100
0.0833
0.0833
38
8
316.67
160.00
0.082
0.042
1.810
0.927
120
1200
2225
100
100
100
0.0833
0.0833
0.0833
375
2600
6017
312.50
216.67
270.43
0.081
0.056
0.070
1.788
1.236
1.545
1852
100
0.0833
7706
416.09
0.108
2.384
1.059
1.236
2.648
∑PI=
1.00
∑PI=3848 1.00
22.07
1200
.86
Source: Field Survey and the data compiled from secondary source i.e. Economic Survey 2012-13 and
Union Budget 2013-14 Data book for DCH; 18th December 2013.
Note: P0 = Price of base year (2001), P 1= Price of study or current year (2011),
IR= Inflation Rate= P1-P0/P0x100
Contribution Ratio (CR): The individual item‟s price index share in total sum of price
index is „contribution ratio‟ of that item to inflation index; it is calculated by formula:
CR=PI/∑PI. In base year 2001, the contribution ratio of each item is 0.0833 when
calculated inflation rate is one. It means every item equally contributed to general price
or inflation rate in base year. But in study or current year 2011 the share of each item in
inflation rate shows the trend and nature of that items price that can help us to ascertain
the cause for inflation and enable us to device the policy measure to control or cure the
inflation.
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76 PRAGATI: Journal of Indian Economy, Vol. 1, Issue 2
The trends of contribution ratio during 2001 to 2011 are shown in Figure 3. It
indicates that the item electricity, tax burden, land and higher education prices have
increasing trends which are above previous level i.e. 0.0833 but the rest items have
declining trends which are less than previous level .ie.0.0833; of course the price index
increased to 220.74 in 2011 and price index of all individual items too increased but in
asymmetrical way. In other words, only four items have upward trend and the rest have
downward trend so the upward trend items are the causes for rise in inflation rate during
2001-2011 period (Figure 3).
Change in Price Index
Figure 3: Trends in Contribution Ratio
0.2
0
2001
0
2
4
6
8
Items
10
12
14
2011
Each item’s share in inflation rate: From the finding of Figure 3, the share of each item
in inflation rate is calculated that is shown in the last column of Table 1. ( Each item‟s
share in Inflation rate=CR/1xIR}. The inflation rate increased to 220.74% during 20012011, period of 10 years, but annual average inflation rate is 22.07%. Each item‟s share
or contribution to inflation rate is illustrated in Figures 4 and 5.
When each item‟s share in inflation rate is calculated it is found that four items
namely electricity, land, higher education and tax-burden have higher contribution to
inflation rate than the rest of the items. Each item‟s share in inflation rate in percentage
also validates the said finding of the study (Figure 5).
Cost Component Index of Item: Each item‟s contribution (in %) in 22.07% inflation rate
or price-rise is studied above but equally it is necessary to evaluate contribution of each
component‟s share in rise in price of the item used in construction of price index for the
purpose of devising measure to control inflation in the economy. In above index meal‟s
contribution to inflation rate is 1.059 (Meal‟s Share= 0.048/1x22.07=1.059). The cost of
preparing meal consists of several components; their nature and trend help us to assess
the trend of meal‟s price so „cost-component index‟ could be constructed for this purpose
Manipulation Theory of Inflation
(Table 2). For example, the meal price Index is 65/35 x 100= 185.7; meal inflation rate is
P1-Po/Pox100= 65-35/35x100=85.71, it is of 10 year duration so the average annual
meal inflation rate is 85.71/10=8.57%. When CCI (CI= C/1 x IR) is calculated of all cost
components meal price, transport, tax, managerial cost and welfare cost are found as
main causal factor of meal inflation; except mentioned four cost-components rest have
declining trends. Similarly the cost-component index of all the items of price index could
be calculated to find out the main causal factors of inflation rate and its trends. Since the
aim of this research study is to develop the new method of inflation rate measure, I have
taken construction of only meal price cost-component index.
Figure 4: Each Item’s Share in Inflation Rate (22.07%)
Def fin,
1.545
Gold, 1.236
Wage,
1.788
Cement,
0.927
Tax Bur,
2.384
Diesel, 1.81
Meal, 1.059 Cloth,
1.236
Electr,
2.648
Land, 3.399
H Edu, 2.67
Med Exp,
1.346
Figure 5: Each Item’s Percentage Share in Inflation Rate
Tax Bur
Def fin 11%
Gold 7%
6%
Meal Cloth
5%
6% Electr
12%
Land
15%
Wage
8%
H Edu
12%
Cement
4%
Diesel
Med Exp
8%
6%
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78 PRAGATI: Journal of Indian Economy, Vol. 1, Issue 2
Table-2: Cost-Component Index (CCI) of Meal Price
Cost
Components
Basic
Materials
Wage
Electricity
Fuel
Transport
Tax
Managerial
Cost
Profit-Margin
Welfare Cost
Environment
Total=N=10
Base Year 2001
Per
Index
capita P1/P0X100
(Rs)
10
100
Contribution
(C)( PI/∑PI
0.1
Base Year 2011
Per
Index
capita P1/P0X100
(Rs)
18
180
0.085
Share:
C/1 x
IR
(%)
0.728
Contribution
(C) PI/∑PI
5
1.1
1.5
2
2
2
100
100
100
100
100
100
0.1
0.1
0.1
0.1
0.1
0.1
8
2
3
6
5
5
160
181.8
200
300
250
250
0.075
0.086
0.094
0.141
0.118
0.118
0.643
0.737
0.806
1.208
1.011
1.011
10
0.4
1
35
100
100
100
1000
0.1
0.1
0.1
1.0
15
1
2
65
150
250
200
2121.8
0.071
0.118
0.094
1.000
0.609
1.011
0.806
8.57
Source: Field survey
Co-efficient of Correlation: There is perfect association between general price level rise
and price indices of all selected items (Table 3). The base year (2001) computed price
index is 100 (=1200/12), denoted asX0 and study year (2011) price index 321
(=3848.86/12), denoted as X1 so it is written as ∆x= X1-X0 =321-100; ∆y denotes
change in value of Y variables (selected 12 items) from 2001 to 2011 so Y= y1
y2...........y12.
Table 3: Co-efficient of Correlation between x and y
Items
(Y) α=∆x/∆y (2)
(1)
Meal
(y1)
2.27
Cloth (y2)
1.94
Electricity (y3) 0.61
Land (y4)
0.45
H Education 0.60
(y5)
Med Exp (y6)
1.66
Diesel (y7)
1.02
Cement (y8)
3.68
Wage (y9)
1.04
Gold (y10)
1.89
Def Finance 1.30
(y11)
Taxation (y12)
0.70
Total
Source: Compiled from Table-1
r2
0.39
0.52
1.65
2.23
1.66
r =√ α β
(4)
1.001
1.004
1.003
1.001
0.999
1.001
1.008
1.006
1.001
0.998
-0.001
-0.008
-0.006
-0.001
+0.002
0.60
0.98
0.27
0.96
0.53
0.77
0.999
1.000
0.999
1.001
1.000
1.000
0.998
1.000
0.998
1.001
1.000
1.000
+0.002
0.000
+0.002
-0.001
0.000
0.000
1.43
1.000
1.000
0.000
β=∆y/∆x
(3)
(5)
1-r2
(6)
Manipulation Theory of Inflation
Similarly α=∆x/∆y denotes X1-X0/Y1-Y0 and β=∆y/∆x denotes Y1-Y0/ X1-X0;
this method or formula helps us to calculate the correlation between dependent variable
(General Price Index, i.e. x) and independent variables (Index of each item i.e. y1
y2...........y12). The correlation between X and Y i.e. X= f(Y) of all the 12 items are
computed in column (2) and the correlation between Y and X i.e. Y= f(X) of all the 12
items are computed in column (3); the co-efficient of correlation (r) of all independent
variables is computed in column (4) by using method or formula r =√ α β ; column (5)
denotes the computed value r2 (square of r) of all independent variables; column (6)
denotes the computed value 1- r2 of all independent variables. To calculate Multiple
Correlation Coefficient, the following equation is used:
Rx.y =√ 1- (1-r2xy1) (1-r2xy2)…………. (1-r2xy12)……….. (Equation-1)
Rx.y stands for „co-efficient of multiple correlation‟ between variable-x (General
Price Index- dependent variable) and variable-y- price indices of items y1,2,3,….12,
independent variables). It is calculated on the basis of Table-1 values (Price Indices).
When we substitute the values from Table-3 in equation-1, it is found that:
Rx.y =√ 1- (-0.001) (-0.008) (-0.006)…………. (0.000) = 1
If the value of coefficient of multiple correlations is equal to 1, there is perfect
association between inflation (x-variable) and its components (y-variables); if it is equal
to zero, there is no relation between dependent and independent variables. It shows that
there is perfect association between the general price level rise and rise in price of 12
items. Besides, one more thing to be noted here is that the items meal, cloth, electricity,
land and wage correlation values are greater than one; the items higher education,
medical expenses and cement correlation values are less than one; the items diesel, gold,
deficit finance and taxation correlation values are equal to one so it implies that these
four items are perfectly associated with general price level.
Miracles and Myths: The second hypothesis that I wish to test is that „miracle factors are
more responsible for inflation than myths and controlling of manipulations could control
inflation‟. The myths are causal factors of inflation such as excess aggregate demand,
aggregate-supply shortage, natural calamities, wars, etc.; they have natural effects on
general price level. The miracle factors are deliberate interferences by some agents in
influencing price-level to get their greed satisfied such as raising more tax-revenue to
meet government extravagances, politicians‟ money-monger policy, deficit finance,
manipulators of assets‟ market like land, gold, etc. bureaucrats‟ selfishness, producers‟
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80 PRAGATI: Journal of Indian Economy, Vol. 1, Issue 2
margin of profits policy, managerial-costs and nuisances of government policies
(mismanagement of government schemes). In above analysis, Table-1 reveals that the
electricity-price policy, land or real estate business policy, gold and stock-exchange
policy and taxation policies are the main manipulators or causal factors for raising
general price level; Table-2 reveals that the factors like transport-cost, taxation,
managerial-cost and welfare-scheme-cost persistently kept continuous general price
rising but other causal factors had declining trends, their contribution was less than their
previous contribution i.e. 0.1. Thus, this analysis revealed the truth behind inflationary
situation is that (i) the myth is that the usual causal factors could be controlled by the
normal fiscal and monetary measures and (ii) the miracle is that the self-interest or
greed-oriented manipulators‟ policies such as profit-margin, high-wage, highereducation fees, land or real estate artificial business-boom, electricity-charges, gold and
stock exchange and multiple taxation are more responsible for persistently continuous
general price rise. The control of these miracles or manipulators by government could
effectively control inflation.
6.0 Summary, Findings, Suggestions and Conclusion
It is fact that that inflation is a hurdle to growth and development both at micro
and macro levels. It is believed that the inflation is the outcome of imbalance between
demand and supply force - excess demand or shortage of supply, but forces behind them,
the manipulators, play a crucial role in creation of this economic situation. The
construction of the inflation index of selected 12 items which included consumer goods,
producers-goods and assets reveals the truth that factors like government policymeasures, human resource development and the asset-business are the main manipulators
of inflation; it is getting worst in India because of these causal factors. Unless these
manipulators are controlled strictly by government, all inflation controlling efforts
become vain and meaningless.
The main findings of the study and appropriate suggestions for controlling
inflation through curbing manipulators activities in national and global interest are
discussed below.
(i) Producers-goods, assets-dealings and government finance play a crucial role in
inflation melodrama. The operational costs of production of goods and services have
been increasing as a result of higher taxation, wage-increment, rising-price of basic
materials and transport cost, etc. These aspects of producers goods have been supporting
the rising inflation rate. The real asset dealings have created more black money in
circulation and it has adverse effects on the entire economy. Lands became costly that
Manipulation Theory of Inflation
leads to rising of cost in construction industries. To meet its expenses on government
schemes, plan and non-plan, the government found easy way of collecting revenue from
indirect-taxes, public borrowing and deficit financing that have the major adverse effect
on general price level.
(ii) Gold, deficit finance, taxation and diesel are perfectly correlated with general price
level. The mounting gold price, deficit finance, taxation and fuel-price (diesel) have the
major impact on inflation-rate. These are the items where manipulation by big politicians
and corporate bulls is much, for instance listing of essential commodities in stock
exchange markets, multiple indirect taxation, raising budgetary deficit, bogus subsidy
and guarantee schemes, etc.
(iii) Curbing of manipulation activities makes anti-inflation measures more effective and
successful. To make monetary and fiscal measures to be effective to control inflation,
there is need for a support policy-measure to curb manipulators and their speculative
activities. The governments must have direct control over asset dealings like gold and
real estates, fee structure of education, producers‟ goods like basic materials, corporatepricing policy and the activities of manipulators in government organizations.
The very controversy between Monetary economists and Keynesian economists
is that while the former believes that the link between inflation and supply of money is
very strong, the latter typically emphasise the role of aggregate demand in the economy
in determining inflation. For Keynesians, the money supply is only one determinant of
aggregate demand. However, in the present day context new economic order with
reforms, the economic freedom has crossed its limit and created economic anarchy in
both national and international markets as a result of which neither monetary factors nor
aggregate demand play a role in determination of inflation; the actors behind the market
forces to keep general price rising continuously in economy are manipulators such as
corporate big bulls, some wealth-monger politicians in power and their collusion with
planners and policy makers. The direct control over these manipulators could help to
control inflation; other-wise the people should be ready to face class-war as it is said by
Karl Marx in his theory of development.
References
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Baumol, William J. and Alan S. Blinder. (2006). Macroeconomics: Principles and
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