The Story of Inflation

The Story of Inflation

1) What happens when things become expensive

2) Let’s say there are 100 people in a Party

3) An announcement is made

4) A very exclusive painting is offered on auction

5) Rs 1 lac starting value

6) People keep making offers and the Painting is pruchased for Rs 10 lac

Now let us look at the same situation but with a little difference

1) This time by some magical intervention, 50 % of the money in the wallets of the 100 people vanish

2) So only 50 % money is left with them

3) Now will the painting fetch more or less money?

4). Clearly less and it will perhaps get sold for Rs 5 to 6 lacs because the buying force got halved

5) By reducing the supply of available money the same item got cheaper

6) This is how Inflation is brought under control

7) Instead of someone stealing some wallets, the way this is done is by increasing interest rates

8) The moment interest rates are increased people’s wallets come under pressure

9) Now they have to pay higher EMIs and to that extent money disappears from their wallets

10) This is how Inflation and interest rates are related with each other

11) When interest rates are increased, some people who had kept their money in volatile stock markets will now sell the stocks and invest the money in higher yielding debt instruments

12) Therefore when interest rates go up, 3 things happen

a) Inflation comes down

b) People lend more money to realise. better guaranteed returns

c) They sell their shares to get the money to lend at higher rates. This selling presure in the stock market can being the market down

I rest my case