Inflation

Inflation

• Inflation: “Inflation is the sustained rise in the average prices
  of a basket of goods and services”.
• 
  Types
• According to the magnitude of inflation.
• According to the sources of inflation.

Types of inflation-based on rate

• Moderate (Low and stable – single digit)
• Galloping (High and unstable – double or triple digit)
• Hyperinflation (Extreme and uncontrollable – very large
  numbers)

Two measures of Inflation

WPI (Wholesale Price Index)

• Captures the price changes in the wholesale market (B2B).
• Excludes the services sector.
• Base year = 2011-12

CPI (Consumer Price Index)

• Captures the price changes in the retail market (B2C).
• Includes both goods and services.
• Base year = 2012

WPI

• Base year updated from 2004-05 to 2011-12.
• The number of items has been expanded from 676 to 697.
• A total of 199 new items have been included and 146 old items have been excluded.
• Based on the suggestions from Saumitra Chaudhuri working committee.
• Provided by Economic Advisor (Commerce Ministry).
• Released once a month.

	base year (2011-12)
	number of items	weight
primary articles	117	22.62
fuel and power	16	13.15
manufactured items	564	64.23
total	667	100

WPI – Ramesh Chand Committee

• Include both goods and services in the calculation.
• Increase the number of items in the basket from
  697 to 1196.
• Update the base year to 2017-18.
• Suggest adding more products to the list
• Herbal plants (aloe vera, menthol, fennel seed etc).
• Green tea, sanitizers, mushrooms, brown rice etc.

CPI

Previously three different types – IW, UNME and AL.

• Changed to CPI (Combined), CPI (Urban) and CPI (Rural)
• Number of items
• Rural = 448
• Urban = 460
• Combined = 299
• Base year = 2012
• Calculated by NSO

	Industrial Workers(IW)	Urban Non-Manual Employees(UNME)	Agricultural Labours (AL)
base year	2016	1984-85	1986-87
number of articles	463	180	60
services included	yes	yes	no
published by	ministry of labour	MoSPI (Ministry of statistics and programme implementation)	ministry of labour

CPI & WPI – Divergence

Flexible Inflation Targeting (FIT)

• The government has delegated the responsibility of managing inflation to RBI.
• MPFA was agreed upon by GoI and RBI.
• It was signed in 2015 and implemented from 2016.
• The government has modified the RBI Act for this purpose.
• Under this framework, the central government has set the inflation target in
  consultation with RBI.
• According to this, RBI has to keep inflation at 4% (with a margin of 2% on either
  side).
• If inflation deviates from the 4% target by more than 2% for three consecutive
  quarters, then RBI has to justify to the government the reasons and the measures
  to restore inflation within the range.
• Every 6 months, it has to publish a report indicating-the current level and the
  expected trend of inflation.
• The experience for last five years has shown that
• The inflation rate has stayed within the target range (2% to 6%) for most of
  the time despite the uncertainties and shocks in the economy
• One of the factors driving up the inflation rate in recent months has been
  supply-side constraints such as rising commodity prices, which are outside
  the RBI’s influence
• The average inflation rate for five years (until 2021) has been around
  3.47%, compared to the average of 5.7% for five years before the inflation
  targeting regime
• The monetary policy making process has become more transparent

Inflation Targeting – headline or Core?

Headline Inflation

• The common people are mostly affected by the rising prices of food and fuel.
• Inflation has been brought under control since the inflation target was introduced in
  2016, after being in double digits for a long time.
• This is not the right time to make a policy change that would allow RBI to relax its focus
  on price stability.

Core Inflation

• Core inflation is a more reliable measure of inflation than headline inflation.
• Headline inflation includes the commodities whose prices fluctuate a lot.
• Price volatility may hamper the policy making process.

Effects of inflation

• Erodes purchasing power – the same amount of money can buy fewer
  goods and services.
• Lowers real rate of returns
• Returns after accounting for inflation.
• The higher the inflation, the lower the real rate of returns.
• Exports – country with higher inflation, exports become less competitive.
• Impacts investment climate.

How to control inflation?

• Reduce the money supply – RBI through the monetary policy.
• Government reduces the expenditure.
• Government increases the income tax rate.
• Households start saving more.
• Increase the production.

Other concepts

• Deflation: A decline in the average prices of goods and services.
• Disinflation: A reduction in the inflation rate or a slower increase in prices.
• Core inflation: The inflation rate that excludes the volatile items (such as food
  and energy) that may distort the overall trend.
• Headline inflation: The inflation rate that includes all the items in the basket of
  goods and services.
• Inflation Tax
• It is the loss of value of money as the prices of goods and services increase.
  Stagflation
• A condition where the economy faces high inflation and high unemployment at
  the same time.
• It is a mix of inflation and stagnation.
  Base effect
• The influence of the price level of the base period on the calculation of the
  inflation rate in the current period.
• Skewflation :
• A condition where some goods and services experience inflation while
  others experience no inflation or deflation.
• It was observed in India in the previous decade.
  Reflation :
• A policy of the government to boost the output or the growth of the
  economy to overcome a slump or a contraction.
• Imported inflation
  A rise in the general price level due to an increase in the cost of imported
  goods or services.
• Wage price spiral
  A feedback loop in which higher inflation leads to higher wages, which in
  turn fuels more inflation.

Phillips Curve

• A curve that shows the negative relationship between the inflation rate
  and the unemployment rate.

Nominal (Current) and Real (Constant)

nominal= based on current market prices

real= based on prices in base year

GDP Deflator

• A measure of inflation that compares the current and base year prices of
  all goods and services produced in an economy.
• Indicates how much the GDP has grown due to higher prices rather than
  higher output.
• Includes a wider range of goods and services than other price indices.

GDP= Nominal/Real GDP