With reference to Indian economy, demand-pull inflation can be caused/increased by which of the following?

1. Expansionary policies
2. Fiscal stimulus
3. Inflation-indexing wages
4. Higher purchasing power
5. Rising interest rates

Select the correct answer using the code given below.

[UPSC Civil Services Exam – 2021 Prelims]

(a) 1, 2 and 4 only

(b) 3, 4 and 5 only

(c) 1, 2, 3 and 5 only

(d) 1, 2, 3, 4 and 5

Answer: (a)        

Explanation:

• Inflation refers to the rate at which prices of goods and services rise within a specified timeframe.
• It is commonly measured as a comprehensive indicator, such as the overall price increase or the rise in the cost of living in a country.
• Inflation quantifies the extent to which a specific set of goods and services has become more expensive over a particular period, usually a year.

The two primary types of inflation are as follows:

• Demand-pull inflation: This occurs when there is an upsurge in the aggregate demand within the economy.
• Cost-push inflation: This arises when there is an increase in the cost of raw materials, higher taxes, and similar factors that influence production costs.

Demand-pull inflation can primarily be attributed to the following factors:

• Depreciation of the currency: When the value of the domestic currency declines, it leads to an increase in the prices of imported goods, thus pushing up overall demand and contributing to inflation.
• Increased government spending (fiscal stimulus): When the government adopts expansionary policies such as higher government consumption or lower taxes, it injects more money into the economy, boosting economic activity and demand, thereby driving inflation.
• Higher purchasing power: When consumers have greater confidence and spend more while taking on additional debt, it stimulates demand, leading to a sustained increase in prices.
• Asset inflation or increase in Forex reserves: A sudden surge in exports can result in a depreciation of the currency involved, which in turn can drive up prices in the domestic economy.
• Inflation-indexing wages: Indexing wages to inflation, where wages adjust to changes in inflation, does not directly contribute to demand-pull inflation as it aims to mitigate the impact of inflation on wages, ensuring purchasing power remains relatively stable.
• The rising interest rate: While a rising interest rate can affect the money supply and borrowing costs, it does not directly cause demand-pull inflation.

In summary, demand-pull inflation is primarily caused by factors such as currency depreciation, increased government spending, higher purchasing power, asset inflation or increased Forex reserves, while inflation-indexing wages and rising interest rates have indirect or no impact on demand-pull inflation.