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.