Inflation is defined as an increase in the price of goods and services from its general level. There can be many reasons behind the increase in prices or we can say behind the inflation. Broadly it is categorized into two parts i.e. Demand side inflation and supply side or cost-pull inflation.
The Two Sides of the same coin:-
Demand-side inflation occurs when there is excessive demand but supply is not there to fulfill that demand. And there can be many reasons behind it, one of them is when some products get very popular or many more. Whereas supply side or cost-pull inflation occurs when there is a hindrance to the cost of a factor of production i.e. land, labor, and machine. That is when any of these factor’s price increases the price of the product will automatically increase.
Govt. and Central bank plays a major role in order to keep inflation down. Since increasing of inflation rate after a particular point is not good for the economy. So, if there is a flood and there is a limited supply of crops and cereals, govt. buys it from the supplier and supply it to the public at a subsidized rate. So that neither the farmer will have to take loss nor the public.
On the other hand, the Central bank also plays a very important role, at the time of inflation when there is the high price of everything in the market which simply indicates a high flow of money in the economy. This results in the phenomenon where many people won’t even be able to fulfill their basic needs. In order to take control of these scenarios, central bank increases the repo rate (repo rate is a rate at which RBI land money to commercial banks).
The reason behind this increase of repo rate is, when commercial banks are getting money from RBI at a higher rate then they’ll land money in higher rate too. Which results in less borrowing from banks and decreased the flow of money from the market. In addition to it, people get attracted toward the high rates and they start saving money into the banks.
Since saving money into the bank will give them high interest on their money and ultimately, they will end up with saving rather than spending. This helps the government to absorb liquidity from the market. So that again everything will be in control.
High Inflation is never good for any economy since ultimately people are going to suffer from it. Due to limited supply or increased price or reducing the value of a currency. Thus, a perfect balance of financial inflow and outflow of cash is maintained to ensure harmony in living.