Friday, December 4, 2009

NEGATIVE INFLATION - Whom are you fooling dude?

NEGATIVE INFLATION - Are we heading towards a recession?

A few months back, this was the headline in almost every news channel and news paper (assuming the language of the channels and papers constant, ceteris paribus). Common people (or cattle class) were ecstatic as because negative inflation signifies that the general price level is recording a sustained gradual fall over time, which means cheaper goods and increased value of money.

On the other hand, the Industrialists (or sucker class, as I love to call them) were devastated at this sight, as it implies lesser profits, and of course, less sucking. The Economists believe that negative inflation is not at all a healthy signal for an economy. On the contrary, a mild inflation acts as a lubricant in the wheels of an economy. Allow me to explain this point. A mild inflation signifies a very slow, gradual, sustained increase in the general price level. A mild dose of inflation is required as it encourages the producers to produce more, thus boosting production, output and employment. On the other hand, the general income level rises due to this, and consumers have more purchasing power in their hand, which increases the level of Aggregate Demand in the economy.

Oh sorry, I am deviating from the point I started to explain. We already know that the price of general goods are at an all time high. Look at the price of vegetables. At this point of time, potatoes are generally Rs. 4/5 per kg, but now its Rs 30 per kg (plus minus something, since I am not a regular visitor to the veg market). Inspite of this, the inflation is negative - BULLSHIT.

Now the organisation dedicated to release these figures are not dumb asses. This apparently vague comments have deep rooted mathematics embedded inside them. There is something called Price Index (I would love to teach this concept, but for this you need to attend my Statistics classes ... lol) which records changes in prices of the current year as compared to the base year. Now in the Inflation Equation, weights are assigned to basket of commodities, like agricultural commodities, industrial commodities, durable consumer goods, etc.

Now, if you notice, the price of industrial and consumer goods didnt increase proportionately. Its the agricultural output prices that screwd up our life. The Economists in these agencies removed the higher weight from the agricultural output to the other commodities whose prices didnt record any upward thrust. After this, high school mathematics follows. Obviously, the inflation figures reveals a downward drive and eventually surpasses the bottomline. See, the beauty of mathematics - which I keep on telling my students. That is why Mathematics is the most beautiful subject in the world.

Now, the question is "Why did the government do this?"

Well, the answer is - The government is forced to show a lower fiscal deficit to the IMF in order to secure long term loans. Soaring inflation prices doesnt help the case. So, lowering of inflation figures helps lower the fiscal deficit (atleast on paper), and thus loans are secured.

Now the question for the readers to answer is -


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