What is the relation between Currency and Inflation?

A few years back “Gold Standard” was uniformly applicable in the whole world, according to which governments were allowed to publish the currency amounting to the government’s gold reserves only. This system was installed to provide a basis of currency publication.

To explain the relationship of currency with the inflation, it’s very important first of all to understand what is currency? A currency of any country is basically a bill issued by the appropriate authority of that country, and through this bill government announces that it is liable to pay the bearer an amount of gold equal to the value mentioned on currency. To bear this liability it’s very important for the government to keep the gold reserve of the amount equal to total currency in economy. This links the publication of currency directly to the gold reserves of the government or any other authorized reserve body. In India the authorized body to regulate the publication of currency is RBI (i.e. Reserve Bank of India).

After understanding the publication criteria of currency now we can easily understand its connection with inflation. Inflation is actually the rise in the level of prices of various goods and services in a particular economy over a particular period of time. Situation of inflation arrives whenever money supply in economy increases, because with increased disposable income people spend more, which disturbs the demand and supply equation. When demand in economy increases keeping the supply at same level, bargaining power of producers also increase as a result prices inflate. This is not the only reason of inflation, but it is one of the major reasons of inflation in developing countries like India.

Now, if we look at everything in an integrative manner, we can locate out that money supply in India is totally under regulation of RBI. Whenever money supply in country reaches beyond a particular level, RBI increase the Statutory Liquidity ratio (SLR) and Cash reserve ratio (CRR), to match these ratios banks also increase their interest rates, which slows down the flow of money in economy, as a result purchasing power of consumers also come down, which ultimately reduce the demand and prevents further inflation of prices.

So, it could be clearly seen that supply of money is directly related with the inflation of prices in economy. Now, if some country publishes the currency irrespective of its gold reserve, then it will inflate the prices as well as reduce the foreign exchange value of that particular currency. Usually, countries take such steps to come out of economic depressions, but it is not beneficial on long run.

Written by Lucas Beaumont

Generalist. Wikipedia contributor. Elementary school teacher from Saskatchewan, Canada.

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