It talks about the impact of monetary policy on inflation

1. MONETARY POLICY
& INFLATION

2. WHAT IS MONEY SUPPLY?
• Money supply is one of the important indicator of macroeconomic
environment.
• This refers to the total volume of money circulating in the economy at a
point in time.
• Money supply in an economy determines liquidity conditions in the
market, which in turn impacts interest rate structure and hence the cost of
capital to the firms.

3. CONTD..
• Money supply is basically determined by the central bank of a country (e.g.
Reserve Bank of India) and the commercial banking network.
• RBI has adopted four measures of money supply viz.-M1, M2, M3 and M4 .
• M3(broad money) is most popular from operational point of view. M3
includes time deposits (fixed deposits), savings deposits with post office
saving banks and all the components of M1.

4. WHAT CAUSE INCREASE IN MONEY SUPPLY?
• RBI has the power to print notes, they can hence release more money into
the economy.
• However it is only partly true. Such a process cannot be sustained as more
notes for the same quantity of physical goods in the economy will only
bring down the value of the currency and hence will not benefit anyone.
• After all increase in money supply should be done with an objective to
benefit the economy as a whole by protecting the value of the currency. So,
a government has to exercise restraint in printing notes.

5. FACTORS AFFECTING MONEY SUPPLY
1.Bank credit
2.Deficit financing
3.Foreign exchange reserves
4.Government Expenditure
5.FII inflows

6. WHY IS MONEY SUPPLY IMPORTANT?
• An increase in the supply of money works both through interest rates,
which spurs INVESTMENT, and through putting more money in the hands
of consumers, making them feel wealthier, and thus stimulating spending.
• Business firms respond to increased sales by ordering more raw materials
and increasing production. The spread of business activity increases the
demand for labor and raises the demand for capital goods.
• In a buoyant economy stock market prices rise and firms issue equity and
debt. If the money supply continues to expand, prices begin to rise,
especially if output growth reaches capacity limits.

7. WHAT IS INFLATION??
• A sustained increase in the general level of prices so that a given amount of
money buys less and less.
• In the Keynesian sense True inflation begins when the elasticity of supply of
output in response to increase in money supply has fallen to zero or when
output is unresponsive to changes in money supply.
• Opinion survey conducted in India, USA and many other countries reveal
that inflation is the most important concern of the people as it badly
affects their standard of living.

8. IMPORTANT TERMS RELATED TO INFLATION
• Deflation: is the opposite of inflation when fall in prices occurs.
• Disinflation: is process of bringing down prices moderately from their high
level.
• Stagflation: is a term in macroeconomics used to describe a period of high
inflation combined with low incomes, unemployment, or economic
stagnation.

9. TYPES OF INFLATION
Demand pull inflation
This represents a situation where there is increase in Aggregate Demand for
resources either from the government or the entrepreneurs or the
households. Result of this is that the pressure of Demand can’t be met by the
Currently available Aggregate Supply which result in Aggregate Demand >
Aggregate Supply which is bound to generate inflationary pressure in the
economy.

10. TYPES OF INFLATION
• Cost Push inflation : This is because of large increases in the cost of
important goods or services where no suitable alternative is available. This
may happen if the costs especially wage cost rise.
• Hyperinflation : Hyperinflation is also known as runaway inflation or
galloping inflation. This type of inflation occurs during or soon after a war.

11. CAUSES OF INFLATION
• Inflation due to Monetary expansion (Monetary inflation)
• Inflation due to rise in real aggregate demand (Real inflation)
• Inflation due to contraction in Aggregate Supply

12. MONETARY INFLATION
• It was Milton Friedman who famously quipped, “Inflation is always and
everywhere a monetary phenomenon.” If the quantity of money grows at a
pace greater than warranted by the growth of the economy, then the
excess money supply drives up prices.

13. REMEDIES – MONETARY INFLATION
• If the cause of inflation is instead monetary expansion, aggregate supply
should still be stimulated, but the focus of effort should be constraining
further monetary expansion.

14. REMEDIES - REAL DEMAND INFLATION
• It involves inflation rising as the real gross domestic product rises and
unemployment falls.
• If inflation is caused by strong real demand, the best response may be to
support aggregate supply growth. Part of the solution may be to let prices
rise. Suppliers need incentives to invest in new capacity.
• Stimulating aggregate supply include encouraging business investment;
reducing input costs; and increasing competitive intensity. </li></ul>

15. REMEDIES - REAL DEMAND INFLATION
• If aggregate supply is sufficiently stimulated, inflation may be converted
into balanced economic growth:
• If instead money supply is tightened in the face of strong real demand, the
result will be a surge in interest rates, which may be counterproductive in
this case, as it will be harder for aggregate supply to expand when
borrowing costs are high.