Inflation

Introduction

  • Inflation is defined as a situation where there is sustained, unchecked increase in the general price level and a fall in the purchasing power of money. Thus, inflation is a condition of price rise. The reason for price rise can be classified under two main heads:
  • (1) Increase in demand
  • (2) Reduced supply

Types of Inflation

1) Creeping Inflation

  • In this inflation, the price rise will be in prolonged (Very Slow) phase. So that it also called as the snail or creeper inflation. The rate of change of price would be around 3%. This will be considered as healthier inflation so, nothing to worry about this inflation.

2) Walking or Trotting Inflation

  • This inflation is the warning for the big disaster. The government should take serious plans to control this inflation at this level. If we miss controlling in the root level, then it would be a headache for both the people and gover ent. The rate of change of price level would be around 3 to 10%.

3)

Running Inflation

  • The rate of change of price will be moving very rapidly in more speed). It will affect the economy very adversely. Economist refers the pace with the running horse. The price level percentage would be around 10-20%. 

4) Hyper Inflation (or) Galloping inflation (or) Runaway inflation

  • You can find a monetary collapse and difficult situation among the country. This will be the worst economic condition for any country. The Price rate will be rapidly moving from two digits to three digits like 10% to 20% to 110%. You can’t even buy 1kg of rice or even 2 liter of Milk. Everything will be more costly than before.

5) Headline Inflation vs Core Inflation

  • Having studied inflation rate measurement at different levels, now let’s focus on two terms related to inflation. They are Headline Inflation and Core Inflation.

6) Headline Inflation

  • Headline Inflation is the measure of total inflation within an economy. It includes price rise in food, fuel and all other commodities.
  • The inflation rate expressed in Wholesale Price Index (WPI) usually denotes the headline inflation. Though Consumer Price Index (CPI) values are often higher, WPI values traditionally

7) Core Inflation (Underline Inflation or Non-food Inflation)

  • Core inflation is also a term used to denote the extend of inflation in an economy. But Core inflation does not consider the inflation in food and fuel. This is a concept derived from headline inflation.There is no index for direct measurement of core inflation and now it is measured by excluding food and fuel items Wholesale Price Index(WPI) or Consumer Price Index(CPI).

Causes of Infaltion

There can be two set fectors that can cause inflation in an economy. They are Demand Pull and Cost Push.

Demand Pull Infaltion

  1. Rise in population.
  2. Black money.
  3. Rise in income.
  4. Excessive government expenditure.

Cost Push Factors

  1. Infrastructure bottlenecks which lead rise in production and distribution costs.
  2. Rise in Minimun Support Price(MSP).
  3. Rise in international prices.
  4. Hoarding and black marketing.
  5. Rise in indirect taxes.

Trends in Infalation

Headline Inflation

  • Based on Consumer Price Index-Combined (CPI-C) continued its declining trend for fifth straight financial year (2014-2019). It has remained below 4.0 per cent in the last two years (2017-2019). The decline in 2018-19 was mainly due to low food inflation.

Food Inflation

  • Based on Consumer Food Price Index (CFPI) declined to a low of 0.1% during the last fiscal year 2018. Food inflation based on Wholesale Price Index too declined over the last two financial years (2017-2019)

Inflation based on Wholesale Price Index

  • Remained moderate at 3% in 2017-18, compared to 1. 7% in 2016-17 and -3. 5% in 2015-16

CPI-C based core inflation

  • (CPI excluding the food and fuel group) increased during FY 2018-19 as compared to FY 2017-18. However, it has started declining since March 2019 Core Inflation corresponds to the component of Inflation that is likely to continue for a long period and is not affected by temporary shocks. As headline inflation exhibits volatility due to short run shocks,Central banks in many countries focus on core inflation.

Drivers of inflation

  • CPI-C inflation during FY 2018-19 was driven mainly by miscellaneous group followed by housing as well as fuel and light group. Services inflation has been higher than goods inflation and the gap between the two is growing. In recent times, services inflation has influenced headline inflation as it has contributed more than its weight. Goods inflation, which accounts for a weight of 76.6 per cent in CPI-C, was 2. 6 per cent during FY 2018-19 as compared to 3. 2 per cent during FY 2017-18. In contrast, services inflation, which accounts for a weight of 23.4 per cent, was 6. 3 per cent during FY 2018-19 when compared to 5.0 per cent during 2017-18.

Rural-Urban Inflation

  • Both rural and urban inflation witnessed reduction, but decline in rural inflation is steeper than that of urban inflation since July 2018. The importance of food in determining rural inflation has been declining over the years. In contrast, the role of miscellaneous category i. e. services in determining rural inflation has increased.

State wise Inflation

  • Inflation ranged between (-) 1.9 per cent to 8. 9 per cent across States in FY 2018- 19 compared to 1. 5 per cent to 12. 4 per cent in FY 2017-18. Majority of states States/UTs had inflation rate lower than All India average for FY 2018-19 with Daman&Diu having the lowest inflation followed by Himachal Pradesh.

Trends in Global Commodity Prices

As per the commodity prices published by the World Bank, energy commodity prices have continued their increasing trend in the fiscal 2018-19. Food prices also recorded deflation as per both the World Bank and the Food & Agriculture Organization (FAO).

Efforts to contain inflation Central Government have taken a number of measures to control inflation especially food inflation: General Measures

  • Advisories, issued to State Governments to take strict action against hoarding & black marketing.
  • Regular review meetings on prices and availability of key commodities- are held including the Price Stabilization Fund Management Committee (PSFMC) among others at the highest levels.
  • Announcement of higher Minimum Support Price (MSP) – for various crops to incentivize production, enhance availability and moderate prices of food items.
  • Setting up Price Stabilization Fund (PSF) for procurement of agri-horticultural commodities for their release during lean periods.

Specific Measures

  • Pulses from the buffer are utilized for strategic market intervention for price management, meeting institutional requirements (for schemes like Mid-Day Meal Scheme) and requirement of Army and Central Para-Military Forces.
  • Prohibition on export has been withdrawn on all varieties of edible oils, except mustard oil (Allowed only in packs up to 5 kgs with a Minimum Export Price).
  • Order imposing controls on States/UTs has been withdrawn- in regards to stock limits on edible oils and edible oil-seeds.

Inflation rate

Measurement of Inflation

1) GDP Deflector

  • The Gross Domestic Product (GDP) deflator is a measure of general price inflation. It is calculated by dividing nominal GDP by real GDP and then multiplying by 100, Nominal GDP is the market value of goods and services produced in an economy, unadjusted for inflation (It is the GDP measured at current prices). Real GDP is nominal GDP, adjusted for inflation to reflect changes in real output (It is the GDP measured at constant prices).
  • GDP Deflator = (Nominal GDP/Real GDP) x 100
  • Importance of GDP Deflator
  • There are other measures of inflation too like Consumer Price Index (CPI) and Wholesale Price Index (or WPI) ; however GDP deflator is a much broader and comprehensive measure. Since Gross Domestic Product is an aggregate measure of production, being the sum of all final uses of goods and services (less imports), GDP deflator reflects the prices of all domestically produced goods and services in the economy whereas, other measures like CPI and WPI are based on a limited basket of goods and services, thereby not representing the entire economy (the basket of goods is changed to accommodate changes in consumption patterns, but after a considerable period of time). Another important distinction is that the basket of WPI (at present) has no representation of services sector. The GDP deflator also includes the prices of investment goods, government services and exports, and excludes the price of imports. Changes in consumption patterns or the introduction of new goods and services or structural transformation are automatically reflected in the deflator which is not the case with other inflation measures However WPI and CPI are available on monthly basis whereas deflator comes with a lag (Yearly or Quarterly, after Quarterly GDP data is released). Hence, monthly change in Inlatun cannot be tracked using GDP deflator.
  • Ministry of Statistics and Programme Implementation (MOSPI) comes out with GDF deflator lns National Accounts Statistics as price indices. The base of the GDP deflator is revied o GDP series is changed.

2) WPI (Whole Sale Price Index)

  • Base year 2011-12 is used (on the recommendation of Abhijit Sen Committee) to measure rate of inflation in India (it is for year consumption), on a point of point basis i. e. on a weekly basis viz. inflation during a certain week ending last year as compared to corresponding week ending in the current year (Also known as Base Effect) and also on monthly basis. Under the revamped data series, the number of items have gone up to 697 from 676.
  • The data now has 199 new items and 146 items have been deleted and has quotations from 8, 331 sources compared with 5, 482 in the old series with 63% weight of industrial goods & 22. 62% weight of primary commodities (food articles, fruits, meat, vegetables) & 13. 15% weight of fuel light & electricity. The ministry of commerce and industry has in March, 2012 made a decision to discontinue the weekly WPI of primary articles, fuel and power components as these are some of the most volatile components of Price Index. This index is a pure commodity index & does not include services. WPI is constructed on the basis of whole sale prices of 697 commodities collected from major whole sale markets in India every week.
  • WPI inflation measures the average change in the price of commodities for bulk sale at the early stage of transactions particularly to 4 sectors namely; Agriculture, Mining, Manufacturing and Electricity. The share of these 4 sectors in GDP at current prices was 41.4% in 2011-12. The basket of the WPI covers commodities falling under 3 major groups namely; Primary articles, Fuel & Power and Manufactured products. The prices taken are ex-factory prices for manufactured products, mandi prices for agricultural commodities and ex-mines prices for minerals. Weight given to each commodity covered in the WPI basket is based on the value of production adjusted for net imports.
  • In the new WPI series (2011-12) significant improvement in terms of concept, coverage and methodology has been made. The item basket has been revised with inclusion of new items and exclusion of old ones in order to capture the structural changes that have occurred in the economy. In the updated WPI basket, the number of items has been increased and special efforts have been made to enhance the number of price quotations across the major groups to ensure comprehensive coverage and representativeness.
  • Prices used for compilation do not include indirect taxes in order to remove the impact of fiscal policy. This is in consonance with best international practices and makes the WPI conceptually closer to Producer Price Index’.
  • The new series has the provision to compile WPI Food Index’. This index is compiled by combining indices of Food Articles and Manufactured Food Products. This along with CPI Food Price Index published by CSO would help in monitoring the food inflation effectively.
  • Seasonality of fruits and vegetables has been updated to account for more months as these are now available for longer duration. Large number of fruits and vegetables has been added to the basket to ensure greater representation.

3) CPI (Consumer Price Index)

There are 4 series of CPI:

  1.  Industrial Workers
  2. Rural Labourer
  3. Agriculture Labourer
  4. Urban Non-Manual Employees
  • The first three are compiled! the Labour Bureau in the Ministry of Labour and Employment, and the fourth is compiled by Central Statistical Organization (CSO) in the MoSPI. These four CPIS reflect the effect of price fluctuations of various goods and services consumed by specific segments of population in the country and not reflect the true picture of the price behaviour in the country as a whole.
  • Out of the four series of CPI; CPI (IW) is used to measure inflation. This index with base year 2011-12 has 57% weight given to primary commodities and is calculated monthly. It is calculated on retail prices collected from a major retail market on monthly basis. This index is used to measure cost of living to a common man on which government counts dearness allowance (DA)
  • New Series of CPI Started in 2012
  • Therefore, there was a strong feeling that there is a need for compiling CPI for entire urban and rural population of the country to measure the inflation in Indian economy based on CPI. Thus, now Central Statistics Office (CSO) of the Ministry of Statistics and Programme Implementation has started compiling a new series of CPI for the
  • (a) CPI for the entire urban population viz CPI (Urban);
  • (b) CPI for the entire rural population viz CPI (Rural).
  • (c) Consolidated CPI for Urban + Rural will also be compiled based on above two CPIs
  • Based on the recommendations of US Bureau of Labour Statistics since 2015 new series of CPI is being used that is CPI urban, CPI rural and Consolidated CPI Urban + Rural. The number of items will also increase from 437 to 448 in the rural basket and from 450 to 460 in the urban basket. Compared with the old basket, the weights of the food and fuel groups have been reduced in the new basket. Meanwhile, the weights of the miscellaneous and clothing, bedding and footwear groups have been increased.
  • Since 2015 CPI is used to measure Rate of Inflation; according to RBI as it is more accurate.

4) PPI (Producer Price Index)

  • Abhijit Sen Committee is working on it. Producers Price Index does not take in to account indirect taxes, transport cost and profit margins of traders because this index is calculated at the producers level before the commodity reaches the market so that price rise if any can be arrested at producers level before its impact reaches the consumers.
  • This measures the average change over time in selling prices by producers of goods and services. PPI measures price change from the point of view of the seller. Majority of OECD countries measure inflation based on Producer Price Index (PPI). Already WPI has been replaced in most of the countries by PPI due to the broader coverage provided by the PPI in terms of products and industries and the conceptual concordance between PPI and system the national account. PPI is considered to be technically superior compared to one at wholesale level. However, in India we are still continuing with WPI.

5) Cost-of-Living Indices (COLI)

  • This is different from CPI. This index aims to measure the effects of price changes on the cost of achieving a constant standard of living (i. e. level of utility or welfare) as distinct from maintaining the purchasing power to buy a fixed consumption basket of goods and services. Maintaining a constant standard of living does not imply continuing to consume a fixed basket of goods and services. A COLI allows for the fact that households who seek to maximize their welfare from a given expenditure can benefit by adjusting their expenditure patterns to take account of changing relative prices by substituting that have become relatively cheaper, for goods that have become relativ dearer
  • Service Price Index is also in process. Abhijit Sen Committee is working on it.
  • Revision of Base Year of GDP and Related Macro-economic Aggregates .
  • Macro-economic aggregates of National Accounts like GDP, Savings, Capital Formation, etc. released by CSO are indicators of the country’s economic health,
  • Base Year of National Accounts revised from 2004-05 to 2011-12 in 2015.
  • Revision of Base Year of Consumer Price Index (CPI)
  • Revised series of CPI launched in January 2015
  • Base Year changed from 2010 to 2012
  • Revision of Base Year of Index of Industrial Production (IIP)
  • IIP estimates revised periodically through Base Year Revision. New series of IIP released on 12th May 2017 with change of Base Year from 2004-05 to 2011-12. The structural changes in the industrial sector over the years are better captured in the revised series.
  • New series indices are more robust and representative with the change in methodology of drawing items / weights and factories.
  • The all India index of Industrial Production (IIP) is an indicator that measures the short term value change in the volume of production for basket of industrial products during a given period to that in a chosen base period. The Central Statistics Office (CSO) has revised  the base year for all-India Index of Industrial Production (IIP) from 2004-05 to 2011-12 on 12 May 2017. Revisions in the IIP are needed to maintain representativeness of the items and producing entities and to address issues relating to continuous flow of data.

  • Base year revision captures structural changes in the economy to improve the quality and representativeness of the indices. The revised IIP (2011-12) reflect the changes in the industrial sector and also aligns it with the base year of other macroeconomics indicators like the Gross Domestic Product(GDP) and Wholesale Price Index(WPI). IIP in the new revised series will continue to represent the  Manufaturing,Mining and Electricity sector.

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