With reference to Indian economy, demand-pull inflation can be caused/increased by which of the following?
- Expansionary policies
- Fiscal stimulus
- Inflation-indexing wages
- Higher purchasing power
- 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
- 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.