Macroeconomic Problems and Measures to counter them Fin.

Wiz
Inflation
Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service. The value of a currency does not stay constant when there is inflation. The value of a currency is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a Rs.1 pack of gum will cost Rs.1.02 in a year. After inflation, your Rupee can't buy the same goods it could beforehand. There are several variations on inflation: Deflation is when the general level of prices is falling. This is the opposite of inflation. Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the breakdown of a nation's monetary system. One of the most notable examples of hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month! Stagflation is the combination of high unemployment and economic stagnation with inflation. This happened in industrialized countries during the 1970s, when a bad economy was combined with OPEC raising oil prices.

Causes of Inflation Economists wake up in the morning hoping for a chance to debate the causes of inflation. There is no one cause that's universally agreed upon, but at least two theories are generally accepted: Demand-Pull Inflation - This theory can be summarized as "too much money chasing too few goods". In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies. Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports. Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Costs of Inflation Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different people in different ways. It also depends on whether inflation is anticipated or unanticipated. If the inflation rate corresponds to what the majority of people are expecting (anticipated inflation), then we can compensate and the cost isn't high. For example, banks can vary their interest rates and workers can negotiate contracts that include automatic wage hikes as the price level goes up.

Problems arise when there is unanticipated inflation: Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For those who borrow, this is similar to getting an interest-free loan. Uncertainty about what will happen next makes corporations and consumers less likely to spend. This hurts economic output in the long run. People living off a fixed-income, such as retirees, see a decline in their purchasing power and, consequently, their standard of living. The entire economy must absorb repricing costs ("menu costs") as price lists, labels, menus and more have to be updated. If the inflation rate is greater than that of other countries, domestic products become less competitive.

People like to complain about prices going up, but they often ignore the fact that wages should be rising as well. The question shouldn't be whether inflation is rising, but whether it's rising at a quicker pace than your wages. Finally, inflation is a sign that an economy is growing. In some situations, little inflation (or even deflation) can be just as bad as high inflation. The lack of inflation may be an indication that the economy is weakening. As you can see, it's not so easy to label inflation as either good or bad - it depends on the overall economy as well as your personal situation. The stock and bond markets are very sensitive to its changes because when inflation rises, purchasing power is eroded. The ensuing drop in consumer spending has a negative effect on stock and bond prices. The rate of inflation tends to increase during economic expansions and decrease during recessions. Inflation tends to be moderate during expansions, and high inflation rates tend to hasten the transition from peak to recession. Deflation is rare and occurs only during recessions. Deflation Deflation is a general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can also be caused by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression. Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals. To counter deflation, the Reserve Bank of India (RBI) can use monetary policy to increase the money supply and deliberately induce rising prices, causing inflation. Rising prices provide an essential lubricant for any sustained recovery because businesses increase profits and take some of the depressive pressures off wages and debtors of every kind. This is the opposite of inflation, which is characterized by rising prices (do not confuse deflation with disinflation, which is simply a slowing of inflation). To many economists, deflation is more serious than inflation because deflation is more difficult to control. Deflationary periods can be either short or long, relatively speaking. Japan, for example, had a period of deflation lasting decades starting in the early 1990's. The Japanese government lowered interest rates to try and stimulate inflation, to no avail. Zero interest rate policy was ended in July of 2006. Equity prices begin to decline as people sell off their investments, which are no longer offering good returns, and bonds temporarily become more attractive.

Hyperinflation Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless. When associated with depressions, hyperinflation often occurs when there is a large increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked this causes prices to increase, as the currency loses its value. When associated with wars, hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath. Because of this, sellers demand a risk premium to accept the currency, and they do this by raising their prices.One of the most famous examples of hyperinflation occurred in Germany between January 1922 and November 1923. By some estimates, the average price level increased by a factor of 20 billion, doubling every 28 hours. Stagflation This is a condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation. Stagflation occurs when the economy isn't growing but prices are, which is not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fuelling sharp inflation in developed countries. For these countries, including the U.S., stagnation increased the inflationary effects. Recession A significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP). Recession is a normal (albeit unpleasant) part of the business cycle; however, one-time crisis events can often trigger the onset of a recession. The global recession of 2008-2009 brought a great amount of attention to the risky investment strategies used by many large financial institutions, along with the truly global nature of the financial system. As a result of such a wide-spread global recession, the economies of virtually all the world's developed and developing nations suffered extreme set-backs and numerous government policies were implemented to help prevent a similar future financial crisis. A recession generally lasts from six to 18 months, and interest rates usually fall in during these months to stimulate the economy by offering cheap rates at which to borrow money. What causes a Recession? Many factors contribute to an economy's fall into a recession, but the major cause is inflation. Inflation refers to a general rise in the prices of goods and services over a period of time. The higher the rate of inflation, the smaller the percentage of goods and services that can be purchased with the same amount of money. Inflation can happen for reasons as varied as increased production costs, higher energy costs and national debt. In an inflationary environment, people tend to cut out leisure spending, reduce overall spending and begin to save more. But as individuals and businesses curtail expenditures in an effort to trim costs, this causes GDP to decline. Unemployment rates rise because companies lay off workers to cut costs. It is these combined factors that cause the economy to fall into a recession.

How do we measure Inflation? LowHighRisingDeclining

Measuring inflation is a difficult problem for government statisticians. To do this, a number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year. http://www.unescap.org/stat/meet/keyindic/india_cpi_wpi.pdf

Wholesale Price Index (WPI) - The Wholesale Price Index or WPI is "the price of a representative basket of wholesale goods". Some countries use the changes in this index to measure inflation in their economies, in particular India The Indian WPI figure was earlier released weekly on every Thursday and influenced stock and fixed price markets. The Indian WPI is now updated on a monthly basis. The Wholesale Price Index focuses on the price of goods traded between corporations, rather than goods bought by consumers, which is measured by the Consumer Price Index(CPI). The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction. This helps in analyzing both macroeconomic and microeconomic conditions. In India; Inflation is based on Wholesale Price Index, all India CPI is being released since January 2011 and it will take some time in stabilizing. Monetary policy has also been continuing to target WPI for its price stability objective. In view of above, it has been decided to consider WPI for inflation protection. Consumer Price Index (CPI) - A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living. The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. Sub-indexes and sub-sub-indexes are computed for different categories and sub-categories of goods and services, being combined to produce the overall index with weights reflecting their shares in the total of the consumer expenditures covered by the index. It is one of several price indices calculated by most national statistical agencies. The annual percentage change in a CPI is used as a measure of inflation. A CPI can be used to index (i.e., adjust for the effect of inflation) the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values. In most countries, the CPI is, along with the population census and the USA National Income and Product Accounts, one of the most closely watched national economic statistics. It is sometimes referred to as "headline inflation." Producer Price Indexes (PPI) - A family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller.

How Governments Influence Markets The way Out

In the 1920s, very few people would have identified the government as the major player in the markets. Today, very few people would doubt that statement. Here, we will look at how the government affects the markets and influences business in ways that often have unexpected consequences. Fiscal Policy (Explained in Detail Later) Monetary Policy (Explained in Detail Later) Currency Inflation - Governments are the only entities that can legally create their respective currencies. When they can get away with it, governments always want to inflate the currency. Why? Because it provides a short-term economic boost as companies charge more for their products and it also reduces the value of the government bonds issued in the inflated currency and owned by investors. Inflated money feels good for awhile, especially for investors who see corporate profits and share prices shooting up, but the long-term impact is an erosion of value across the board. Savings are worth less, punishing savers and bond buyers. For debtors, this is good news because they now have to pay less value to retire their debts - again, hurting the people who bought bank bonds based off those debts. This makes borrowing more attractive, but interest rates soon shoot up to take away that attraction. Bailouts - After the financial crisis from 2008-2010, it is no secret that the U.S. government is willing to bailout industries that have gotten themselves into problems. Truth be told, this fact was known even before the crisis. The savings and loan crisis of 1989 was eerily similar to the bank bailout of 2008, but the government even has a history of saving non-financial companies like Chrysler (1980), Penn Central Railroad (1970) and Lockheed (1971 Bailouts can skew the market by changing the rules to allow poorly run companies to survive. Often, these bailouts can hurt shareholders of the rescued company and/or the company's lenders. In normal market conditions, these firms would go out of business and see their assets sold to more efficient firms in order to pay creditors and - if possible - shareholders. Fortunately, the government only uses its ability to protect the most systemically important industries like banks, insurers, airlines and car manufacturers. Subsidies and Tariffs - Subsidies and tariffs are essentially the same thing from the perspective of the taxpayer. In the case of a subsidy, the government taxes the general public and gives the money to a chosen industry/individuals to make it more profitable/economical. In the case of a tariff, the government applies taxes to certain products to make them more expensive, allowing the suppliers to charge more for their product. Both of these actions have a direct impact on the market. Government support of an industry is a powerful incentive for banks and other financial institution to give those industries favorable terms. This preferential treatment from government and financing means that more capital and resources will be spent in that industry, even if the only comparative advantage it has is government support. This resource drain affects other, more globally competitive industries that now have to work harder to gain access to capital. This effect can be more pronounced when the government acts as the main client for certain industries, leading to the well-known examples of over-charging contractors and chronically delayed projects.

Regulations and Corporate Tax - The business world rarely complains about bailouts and preferential treatment to certain industries, perhaps because they all harbor a secret hope of getting some. When it comes to regulations and tax, however, they howl - and not unjustly. What subsidies and tariffs can give to an industry in the form of a comparative advantage, regulation and tax can take away from many more. As the regulations increaser, smaller providers get squeezed out by the economies of scale the larger companies enjoy. The end result is highlyregulated industry with a few large companies that are necessarily intertwined with the government. High taxes on corporate profits have a different effect in that they discourage companies from coming into the industry. Just as states/sectors with low taxes can lure away companies from their neighbours/counterparts, States/Sectors that are taxed less will tend to attract any corporations that are mobile. Worse yet, the companies that can't move end up paying the higher tax and are at a competitive disadvantage in business as well as for attracting investor capital.

Fiscal Policy The Punches

When the economy begins to suffer from serious recession or inflation, Government will almost always intervene to try to improve the situation. Their interventions may or not be good economicsoften they're not!but you can hardly blame the politicians for trying. Nobody wants to go down in history like Herbert Hoover, the president who became a widely hated figure for failing to use the government aggressively enough to try to end the Great Depression. Politicians hoping to improve economic conditions have two main tools at their disposal. Fortunately for them (and thus for the rest of us), the basic principles behind them are pretty simple. The core thinking is that inflation and recession are opposites of one another. During periods of recession there is not enough money circulating in the economy. During periods of inflation, there is too much. So the answer to these problems is to either put money in or take money out of the economy. At this point, economists begin to disagree over who should do the putting in or taking out, and which means should be used to do so. Some favor fiscal policy adjusting taxes and government spending. But most prefer monetary policy adjusting interest rates and reserve requirements, and buying or selling bonds. Fiscal policy is set by the Finance Minister and passed by the Parliament; they create the tax system and they decide how the government should spend its money each year. The basic premises behind much of contemporary fiscal policy were introduced by British economist John Maynard Keynes during the Great Depression. Keynes argued, contrary to conventional thinking, that the market and the economy could not regulate itself. During periods of recession, consumers hold on to their money rather than spending it. Businesses were similarly afraid to expand operations and hire more workers. Therefore, the government needed to jump-start the economy by injecting some money into it. The tools for doing so were tax rates and government spending. By lowering taxes people had money to spend; they could buy cars and appliances, or convert their garage into a game room. All of this put people to work stimulating even more spending and job growth. By increasing government spending, the government put money directly into the economy. Building a dam, extending unemployment benefits, or hiring more teachers also put money into circulation and, according to Keynesian fiscal theory, stimulated economic growth. Keynes argued that during periods of recession aggregate demand (AD)the total demand of consumers, businesses, and government at various price levels needed to be stimulated through government action. Through tax cuts and increased government spending, aggregate demand (AD1) would be increased (AD2).

Of course, it gets more complicated than this. For starters, policymakers now debate whose taxes should be cut during periods of recession. Traditional Keynesian fiscal policy emphasizes putting money into the hands of middle and lower-class consumers, thereby stimulating the demand side of the economy. Others argue that more permanent growth is achieved by cutting business and corporate taxes, and by reducing capital gains taxes and personal income tax rates for wealthier taxpayers. According to these supply-side theorists, the money saved through these sorts of tax cuts will be reinvested in new businesses and large-scale expansion, thus generating more jobs. Regardless of whose taxes you cut, however, this course of action may lead to government budget deficits - that is, government spending may exceed government income. In response, some argue that short-term deficits are acceptable since once the economy starts to grow, tax revenues will increase. Others argue that deficits saddle future generations with debt and lead to high interest rates, crippling future growth. Examples include changing tax rates, increasing Social Security payments and increasing or decreasing government spending. Based on the theories of English economist John Maynard Keynes. Fiscal policy seeks to stimulate demand and output in periods of business decline by increasing government expenditures and cutting taxes as a means of increasing disposable income. The process is reversed to correct for overexpansion.

Fiscal Policy Options To Fight Recession: Reduce taxes Increase government spending To Fight Inflation: Increase taxes Reduce government spending Why It Matters Today This one's easy: looked at the news lately? Just about everybody wants us to get out of this recession, to restore robust economic growth. But what's the best way to do that? Keep the government out of things and let the economy run its course? Or take deliberate government actions to stimulate the economy?If you want some kind of stimulus, should it come in the form of tax cuts (and if so, for whom)? Or should it take the form of increased government spending? Some Side Effects Just like monetary policy, fiscal policy can be used to influence both expansion and contraction of GDP as a measure of economic growth. When the government is exercising its powers by lowering taxes and increasing their expenditures, they are practicing expansionary fiscal policy. While on the surface, expansionary efforts may seem to lead to only positive effects by stimulating the economy, there is a domino effect that is much broader reaching. When the government is spending at a pace faster than tax revenues can be collected, the government can accumulate excess debt as it issues interest bearing bonds to finance the spending, thus leading to an increase in the national debt.

When the government increases the amount of debt it issues during expansionary fiscal policy, issuing bonds in the open market will end up competing with the private sector that may also need to issue bonds at the same time. This effect, known as crowding out, can raise rates indirectly because of the increased competition for borrowed funds. Even if the stimulus created by the increased government spending has some initial short-term positive effects, a portion of this economic expansion could be mitigated by the drag caused by higher interest expenses for borrowers, including the government. Another indirect effect of fiscal policy often overlooked, is the potential for foreign investors to bid up the currency in their efforts to invest in the now higher yielding bonds trading in the open market. While a stronger home currency sounds positive on the surface, depending on the magnitude of the change in rates, it can actually make domestic goods more expensive to export and foreign made goods cheaper to import. Since most consumers tend to use price as a determining factor in their purchasing practices, a shift to buying more foreign goods and a slowing demand for domestic products could lead to a temporary trade imbalance. These are all possible scenarios that have to be considered and anticipated. There is no way to predict which outcome will emerge and by how much, because there are so many other moving targets, market influences, natural disasters, wars and any other large scale event that can move markets. Fiscal policy measures also suffer from a natural lag, or the delay in time from when they are determined to be needed, and the time their measures pass through congress and ultimately the president. From a forecasting perspective, in a perfect world where economists have a 100% accuracy rating for predicting the future, fiscal measures could be summoned up as needed. Unfortunately, given the inherent unpredictability and dynamics of the economy, most economists run into challenges in accurately predicting short-term economic changes.

Monetary Policy The Kicks

Overview Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve policy goals). The beginning of monetary policy as such comes from the late 19th century, where it was used to maintain the gold standard. Monetary policy is referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money or decreases the interest rate in the economy, and a contractionary policy decreases the total money supply or raises the interest rate. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to combat inflation. Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight if intended to reduce inflation. There are several monetary policy tools available to achieve these ends: increasing interest rates by fiat; reducing the monetary base; and increasing reserve requirements. All have the effect of contracting the money supply; and, if reversed, expand the money supply. Within almost all modern nations, special institutions (such as the Reserve Bank of India, the Bank of England, the European Central Bank, the Federal Reserve System in the United States, the Bank of Japan or Nippon Gink, the Bank of Canada or the Reserve Bank of Australia) exist which have the task of executing the monetary policy and often independently of the executive. In general, these institutions are called central banks and often have other responsibilities such as supervising the smooth operation of the financial system. The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various credit instruments, foreign currencies or commodities. All of these purchases or sales result in more or less base currency entering or leaving market circulation. Usually, the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example, in the case of the USA the Federal Reserve targets the federal funds rate, the rate at which member banks lend to one another overnight; however, the monetary policy of China is to target the exchange rate between the Chinese renminbi and a basket of foreign currencies.

The Indian Scenario Lets just try another one

Monetary Policy can also be used to ignite or slow the economy and is controlled by the Reserve Bank of India(RBI) with the ultimate goal of creating an easy money environment. Early Keynesians did not believe that monetary policy had any long-lasting effects on the economy because 1) since banks have a choice to lend out the excess reserves they have on hand from lower interest rates, they may just choose not to lend and 2) Keynesians also believe that consumer demand for goods and services may not be related to the cost of capital to obtain theses goods. At different times in the economic cycle, this may or may not be true, but monetary policy has proven to have some influence and impact on the economy and equity and fixed income markets.RBI carries some powerful tools in its arsenal and is very active with all these. A. Direct Instruments Cash Reserve Ratio (CRR): The share of net demand and time liabilities that banks must maintain as cash balance with the Reserve Bank. Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities that banks must maintain in safe and liquid assets, such as government securities, cash and gold. Refinance facilities: Sector-specific refinance facilities (e.g., against lending to export sector) provided to banks. B. Indirect Instruments Liquidity Adjustment Facility (LAF): Consists of daily infusion or absorption of liquidity on a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption) auction operations, using government securities as collateral. Repo/Reverse Repo Rate: These rates under the Liquidity Adjustment Facility (LAF) determine the corridor for short-term money market interest rates. In turn, this is expected to trigger movement in other segments of the financial market and the real economy. Open Market Operations (OMO): Outright sales/purchases of govt. securities, in addition to LAF, as a tool to determine the level of liquidity over the medium term. Marginal Standing Facility (MSF): was instituted under which scheduled commercial banks can borrow over night at their discretion up to one per cent of their respective NDTL at some basis points above the repo rate to provide a safety valve against unanticipated liquidity shocks. Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. It also signals the medium-term stance of monetary policy. Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Liquidity of a more enduring nature arising from large capital flows is absorbed through sale of short-dated government securities and treasury bills. The mobilised cash is held in a separate government account with the Reserve Bank.

The most commonly used tool is their open market operations, which the RBI is active in on a daily basis. They purchases and sell government securities in the open market which can increase or decrease reserves with banks while influencing the supply of money whether they are buying or selling bonds. RBI can also change the reserve requirements at banks thus directly increasing or decreasing the supply of money. RBI can also make changes in the Repo rate which is the tool that is constantly receiving attention, forecasts, speculation and the world often awaits the announcements as if any change would have an immediate impact on the economy.

Interest Rates The Barometer

http://pagalguy.com/forums/chit-chat/simplified-economics-and-financediscussion-forum-for-t-102917/p-17020306/
Typically, when the supply of money increases, interest rates fall. And when the supply of money tightens, interest rates increase. So, the RBI actions discussed earlier have an impact on the following: Consumer spending Interest rates on newly issued bonds Market prices of existing bonds: when interest rates rise, the prices of bonds with lower coupon rates decrease, and vice versa

RBI actions can also indirectly impact stocks: When monetary policy expands credit, lower interest rates make bonds less appealing as investments, and stocks more appealing. From the corporate perspective, company earnings may rise because of lower interest expense, which may cause the market price of the stock to rise.

Of course, when the opposite occurs and monetary policy tightens credit, interest rates will rise, earnings will decrease, and the market price of the stock is likely to decrease as well. As interest rates rise, bonds become more attractive to investors. Fiscal vs. Monetary The battle has been hotly debated for decades and the answer is both. For example, to a Keynesian promoting fiscal policy over a long period (25 years) of time, the economy will go through multiple economic cycles. At the end of those cycles, the hard assets like infrastructure such as buildings, bridges, roads and other long-life assets, will still be standing and most likely be the result of some type of fiscal intervention. Over that same 25 years, the RBI may have intervened hundreds of times using their tools and maybe only had success in their goals some of the time. On the other hand, using just one method may not be the best idea, because of the lag in fiscal policy as it filters into the economy. Monetary policy has shown its effectiveness in slowing down an economy that is heating up at a faster than desired pace (inflationary fears), but it has not had the same magnitude of change affect when it comes to quickly inducing an economy to expand as money is eased, so its success is muted.

The Bottom Line Governments may be the most terrifying figures in the financial world. With a single regulation, subsidy or switch of the printing press, they can send shockwaves around the world and destroy companies and whole industries. For this reason, Fisher, Price and many other famous investors considered legislative risk as a huge factor when evaluating stocks. A great investment can turn out to be not that great when the government it operates under is taken into consideration. Though each side of the policy spectrum has its differences, the Policymakers have sought a solution in the middle ground, combining aspects of both policies in solving economic problems. The Fed may be more recognized, as their efforts are well publicized and their decisions can move global equity and bond markets drastically, but the use of fiscal policy lives on. While there will always be a lag in its effects, fiscal policy seems to have greater effects over long periods of time and monetary policy has proven to have some short term success.

P.S. - After reading this tutorial, you should have some insight into inflation and its effects. For starters, you now know that inflation isn't intrinsically good or bad. Like so many things in life, the impact of inflation depends on your personal situation. Some points to remember: Inflation is a sustained increase in the general level of prices for goods and services. When inflation goes up, there is a decline in the purchasing power of money. Variations on inflation include deflation, hyperinflation and stagflation. Two theories as to the cause of inflation are demand-pull inflation and cost-push inflation. When there is unanticipated inflation, creditors lose, people on a fixedincome lose, "menu costs" go up, uncertainty reduces spending and exporters aren't as competitive. Lack of inflation (or deflation) is not necessarily a good thing. Inflation is measured with a price index. The two main groups of price indexes that measure inflation are the Consumer Price Index and the Wholesale Price Indexes. Interest rates are decided in the by the Central Bank. Inflation plays a large role in the RBI's decisions regarding interest rates. In the long term, stocks are good protection against inflation. Inflation is a serious problem for fixed income investors. It's important to understand the difference between nominal interest rates and real interest rates. Inflation-indexed securities offer protection against inflation but offer low returns. RBI had an Inflation-indexed Bond (IIB) issue in June.

References: 1. www.rbi.org.in 2. www.Investopedia.com 3. www.wikipedia.com