n lation and siness le 7.7
price interaction was seen as a plausible cause of was going beyond the upper limit of its healthy
inflation in the year 1935 in the US economy, for range (i.e., 4–5 per cent in the Indian case).
the first time.26
PhilliPs curve
inflAtion Accounting It is a graphic curve which advocates a relationship
A term popular in the area of corporate profit between inflation and unemployment in an
accounting. Basically, due to inflation the profit economy. As per the curve there is a ‘trade off’
of firms/companies gets overstated. When a firm between inflation and unemployment, i.e., an
calculates its profits after adjusting the effects of inverse relationship between them. The curve
current level of inflation, this process is known suggests that lower the inflation, higher the
as inflation accounting. Such profits are the real unemployment and higher the inflation, lower
profit of the firm which could be compared to the unemployment.28 During the 1960s, this
a historic rate of inflation (inflation of the base idea was among the most important theories of
year), too. the modern economists. This concept is known
after the economists who developed it—Alban
inflAtion Premium William Housego Phillips (1914–75). Bill
Phillips (popular name) was an electrical engineer
The bonus brought by inflation to the borrowers
from New Zealand and was an economist at the
is known as the inflation premium. The interest
London School of Economics when propounded
banks charge on their lending is known as the
the idea. In ‘The Relation between Unemployment
nominal interest rate, which might not be the
and the Rate of Change of Money Wage Rates
real cost of borrowing paid by the borrower to
in the United Kingdom, 1861–1957’ (published
the banks. To calculate the real cost a borrower is in Economica in 1958), he provided empirical
paying on its loan, the nominal rate of interest is evidence to support his ideas.29
adjusted with the effect of inflation and thus the
By the early 1960s, an economic wisdom
interest rate we get is known as the real interest
emerged around the world that by following a
rate. Real interest is always lower than the nominal
certain kind of monetary policy, unemployment
interest rate, if the inflation is taking place—the
could be checked forever and at the cost of a
difference is the inflation premium.
slightly higher inflation, unemployment could be
Rising inflation premium shows depleting profits reduced permanently. The central banks of the
of the lending institutions. At times, to neutralise the developed world started framing the required kind
effects of inflation premium, the lender takes the of monetary policies mixing the trade-off between
recourse to increase the nominal rate of interest.27 In inflation and unemployment. The idea became
recent times, it was done by the Indian banks in popular among the developing economies too by
July 2003 to ward off their depleting profits when the late 1960s, though they were a bit confused, as
inflation had crossed the 7 per cent level—the level most of them were fighting the menace of higher
of inflation was threatening to deplete even the inflations (double digit) along with high level of
capital base of the banks. Since then the RBI has unemployment.30
been following a tighter credit policy as inflation
28. Stiglitz and Walsh, Economics, pp. 821–22.
26. J.K. Galbraith, A History of Economics, (London: 29. Penguin Dictionary of Economics, pp. 297–98.
Penguin Books, 1991), p. 205, pp. 267–70. 30. Gerald M. Meier and James E. Ranch, Leading Issues
27. Patrick Lane, Economics (London: The Economist, in Economic Development (New Delhi: Oxford
199), p. 270. University Press, 2006), pp. 37–39.