TASK 4

INFLATION, IIP AND PMI

Sanjay Joseph
JUNIOR RESEARCH ANALYST
BATCH ID: 21WM30 B21
HEDGE SCHOOL OF APPLIED ECONOMICS
MONTI INTERNATIONAL INSTITUTE OF MANAGEMENT
STUDIES
Purchasing Managers Index (PMI)
The Purchasing Managers Index (PMI) is a measure of the prevailing direction of economic trends in
manufacturing. The PMI is based on a monthly survey of supply chain managers across 19 industries,
covering both upstream and downstream activity. The value and movements in the PMI and its
components can provide useful insight to business decision makers, market analysts, and investors, and
is a leading indicator of overall economic activity in the U.S.

How the Purchasing Managers' Index Works

The PMI is compiled and released monthly by the Institute for Supply Management (ISM). The PMI is
based on a monthly survey sent to senior executives at more than 400 companies in 19 primary
industries, which are weighted by their contribution to U.S. GDP. The PMI is based on five major survey
areas: new orders, inventory levels, production, supplier deliveries, and employment. The ISM weighs
each of these survey areas equally. The surveys include questions about business conditions and any
changes, whether it be improving, no changes, or deteriorating.

The headline PMI is a number from 0 to 100. A PMI above 50 represents an expansion when compared
with the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates
no change. The further away from 50 the greater the level of change. The PMI is calculated as:

PMI = (P1 * 1) + (P2 * 0.5) + (P3 * 0)

Where:

P1 = percentage of answers reporting an improvement

P2 = percentage of answers reporting no change

P3 = percentage of answers reporting a deterioration

Other companies also produce PMI numbers, including IHS Markit Group, which puts out the PMI for
various countries outside the U.S.

How the PMI Affects Economic Decisions

The PMI and relevant data produced monthly by the ISM from its surveys are critical decision-making
tools for managers in a variety of roles. An automobile manufacturer, for example, makes production
decisions based on the new orders it expects from customers in future months. Those new orders drive
management's purchasing decisions about dozens of component parts and raw materials, such as steel
and plastic. Existing inventory balances also drive the amount of production the manufacturer needs to
complete to fill new orders and to keep some inventory on hand at the end of the month.

Suppliers also make decisions based on the PMI. A parts supplier for a manufacturer follows the PMI to
estimate the amount of future demand for its products. The supplier also wants to know how much
inventory its customers have on hand, which also affects the amount of production its clients must
generate. PMI information about supply and demand affects the prices that suppliers can charge. If the
manufacturer's new orders are growing, for example, it may raise customer prices and accept price
increases from its suppliers. On the other hand, when new orders are declining, the manufacturer may
have to lower its prices and demand a lower cost for the parts it purchases. A company can use the PMI
to help plan its annual budget, manage staffing levels, and forecast cash flow.

Investors can also use the PMI to their advantage because it is a leading indicator of economic
conditions. The direction of the trend in the PMI tends to precede changes in the trend in major
estimates of economic activity and output, such as the GDP, Industrial Production, and Employment.
Paying attention to the value and movements in the PMI can yield profitable foresight into developing
trends in the overall economy.

COMPARITIVE ANALYSIS OF PMI

MONTH JUL AUG SEPT OCT NOV DEC JAN FEB MAR APR MAY JUN
20 20 20 20 20 20 21 21 21 21 21 21
GROWTH 46.0 52 56.8 58.9 56.3 56.4 57.7 57.5 55.4 55.5 50.8 48.1
%

July 2020
PMI declined to 46.0 in July 2020 from 47.2 in the previous month, below market consensus of 47.8. The
latest reading pointed to a fourth straight monthly contraction in factory activity, as some business
remained closed amid coronavirus lockdown extensions. Output shrank at a slightly faster rate amid
weaker demand conditions. Also, new orders continued to fall markedly, still slower than at the height
of the current crisis and export sales dropped further albeit at the softest pace in four months. The job
shedding rate was little-changed from June and faster than any recorded prior to the coronavirus
pandemic. On the price front, input prices continued to drop, still at the slowest pace in the current
four-month sequence of falling cost, and output charges declined further. Lastly, business confidence
improved to a five-month high, but still well below the historical average
August 2020
PMI increased to 52 in August 2020 from 46 in the previous month, easily beating market consensus of
48.2. The latest reading pointed to the first monthly expansion in factory activity since March, led by an
improvement in customer demand as client businesses reopened following the easing of lockdown
restrictions. Output and new orders expanded at the fastest pace since February, while the job shedding
continued for a fifth consecutive month. At the same time, the rate of increase in backlogs was the
fastest since December 2012. On the price front, input costs rose for first time since March and by the
most since November 2018, due to higher raw material prices. Meanwhile, output charges fell again due
to competitive pressures and efforts to boost sales. Looking ahead, Indian manufacturers remained
optimistic for the next 12 months.

September 2020
PMI surged to 56.8 in September 2020, the highest since January 2012, from 52.0 in August, far above
market consensus of 52.8, amid an easing of COVID-19 restrictions. Output rose for the second straight
month, with the growth rate being the third-quickest in the survey history. Also, there were back-to-
back rises in new orders, with the rate of expansion picking up to the fastest since 2012. At the same
time, overseas sales returned to growth, the first since prior to the escalation of the outbreak, while
buying levels hit its strongest in over 8-1/2 years. Meantime, employment fell for the six months in a
row, with backlogs of works increasing further. Delivery times lengthened for the first time in six
months, amid labour and material shortages at their distributors. On the price front, there was a softer
rise in input costs while output charges were broadly stabilized. Finally, sentiment improved to the
highest in over four years.

October 2020
PMI rose to 58.9 in October 2020 from 56.8 in September, easily beating market consensus of 55.4. The
latest reading pointed to the strongest improvement in the health of the sector in over a decade, amid
ongoing relaxation of COVID-19 restrictions. Output expanded by the most since late-2007 and new
order growth hit its highest level since mid-2008, with export sales rising at a quicker pace. Meantime,
payroll numbers were lowered due to government guidelines related to the pandemic, while backlogs of
work rose the least in the current six-month period of accumulation. Pressure on supplier capacity
subsided, as indicated by the slowest rise in delivery times for seven months. Inflationary pressures,
meantime, remained subdued as seen by a modest increase in input costs and only marginal rise in
selling prices. Finally, business confidence was at a 50-month high.

November 2020
PMI declined to 56.3 in November 2020 from 58.9 in October, below market consensus of 57.3 but still
pointing to a strong expansion amid ongoing loosening of COVID-19 restrictions. Output expanded at a
softer pace, while new orders rose at the slowest pace in three months, with export sales rising at a
softer pace. Meantime, employment continued to decline. Input cost inflation accelerated to the
strongest in two years, due to a faster rise in prices of chemicals, metals, plastics and textiles. As a result,
selling prices rose to a nine-month high. Finally, business confidence faded slightly in November.

December 2020
PMI stood at 56.4 in December 2020, little-changed from the previous month's 56.3 and slightly below
market consensus of 56.6. The latest reading was consistent with a marked improvement in business
conditions across the sector, as the economy continued to recover amid the loosening of COVID-19
restrictions, strengthening demand and improved market conditions. Output and new orders grew
solidly, albeit at the softest pace in four months, while employment declined for a ninth straight month.
On the price front, input cost inflation accelerated to a 26-month high, due to higher prices for
chemicals, metals, plastics and textiles. As a result, output charges rose marginally. Finally, business
confidence weakened to a four-month low as some firms were concerned about the lasting effect of the
COVID-19 pandemic on the global economy

JANUARY 2021
PMI increased to a three-month high of 57.7 in January of 2021 from 56.4 in the previous month and
above market consensus of 56, as the economy continued to recover amid the loosening of COVID-19
restrictions. Output growth accelerated to the fastest pace since last October while new orders rose at
the quickest in three months. Meantime, employment fell further, with job shedding moderated. On the
price front, input cost inflation accelerated to a 28-month high. As a result, output charges rose to the
fastest pace in over a year. Finally, business confidence improved on the back of vaccine rollout,
increased marketing budgets and projects in the pipeline

FEBRUARY 2021
PMI edged down to 57.5 in February of 2021 from a three-month high of 57.7 in the previous month and
matching market consensus, still signaling a strong month of expansion in the manufacturing sector.
Output and new orders continued to grow at solid rates, while employment continued to decline. On
the price front, input cost inflation accelerated to a 32-month high, due to a faster rise in prices of
chemicals, metals, plastics and textiles. As a result, output charges rose modestly. Finally, business
sentiment remained positive, amid forecasts of an improvement in economic conditions and the lifting
of restrictions as the vaccination programme expands.

MARCH 2021
PMI decreased to 55.4 in March 2021, the lowest since last August, from 57.5 in the previous month.
Still, the latest reading signaled a substantial improvement in the health of the sector that outpaced the
long-run series average. Output and new orders expanded at sharp, albeit slower, rates. Also, new
export orders increased further in March, stretching the current sequence of growth to seven months.
Meanwhile, employment declined for a 12th straight month, due to COVID-19 restrictions and a lack of
pressure on capacity. On the price front, the rate of input cost inflation was among the strongest seen
over the past three years. However, selling prices increased only moderately as companies limited their
adjustments to retain a competitive edge and boost sales. Finally, business sentiment weakened in
March

APRIL 2021
PMI was at 55.5 in April 2021, little-changed from 55.4 in the previous month, beating market consensus
of 51.6, indicating a solid improvement in the health of the sector. Both new orders and output
expanded at the slowest pace in eight months, due to an intensification of the COVID-19 crisis. Growth
was attributed to a pick-up in demand and marketing efforts, though hampered by the COVID-19
pandemic. At the same time, new export orders surged to the fastest since last October and buying
levels expanded at one of the sharpest rates seen for nine years. Meanwhile, employment declined for a
13th straight month and the weakest in the current sequence of job shedding. On the price front, the
rate of input cost inflation accelerated to the fastest pace since July 2014, while selling prices increased
to the highest in seven-and-a-half years. Finally, business sentiment strengthened in April.

MAY 2021
PMI fell to a ten-month low of 50.8 in May 2021 from 55.5 a month earlier and missing market
consensus of 52.0, amid a harsh resurgence of COVID-19 cases in the country and its detrimental impact
on the economy. Both output and new orders grew the least in ten months, while there was a
substantial slowdown in the growth of input purchasing and another round of job shedding. May data
continued to signal to lengthen supplier delivery times, with vendor performance worsening for the
third straight month. The deterioration was linked to global shortages of raw materials and the
pandemic. Prices data showed input cost inflation easing to a four-month low but remaining sharp and
above its long-run average. Meantime, firms lifted their selling prices again to protect margins, with the
rate of charge inflation solid but softening from April. Finally, the overall degree of optimism towards
the year-ahead outlook for the output was at a ten-month low.

JUNE 2021
PMI fell to 48.1 in June 2021 from 50.8 a month earlier. The latest reading pointed to the first
contraction in the manufacturing sector since July last year, as a harsh resurgence of COVID-19 and
stricter lockdown measures negatively impacted demand. Both output and new orders shrank. New
export orders decreased for the first time in ten months. Also, buying levels dropped the most since the
series began in March 2005. At the same time, employment fell marginally, with backlogs decreasing for
the second consecutive month. June data continued to signal lengthen supplier delivery times, with
vendor performance worsening for the fourth straight month. Prices data showed input cost inflation
eased to a five-month low while selling prices inflation slowed to a three-month low. Lastly, confidence
dropped over uncertainty when the pandemic can be brought under control.

JULY 2021
The IHS Markit India Manufacturing PMI surged to 55.3 in July 2021 from 48.1 a month earlier and
above market consensus of 50.5. The latest reading pointed to the strongest growth in the sector since
April, as output, new orders, exports, quantity of purchases and input stocks all returned to expansion
territory. At the same time, employment rose marginally, ended a 15-month sequence of job shedding.
Also, the buying activity growth was solid by historical standards. Prices data showed input cost inflation
eased to a seven-month low but remained above its long-run average. As a result, selling prices inflation
slowed to the weakest in 2021 so far. Lastly, confidence strengthened from June's 11-month low, but
remained historically subdued as some companies were concerned about the path of the pandemic.

INDEX OF INDUSTRIAL PRODUCTION

Index of Industrial Production data or IIP as it is commonly called is an index that tracks
manufacturing activity in different sectors of an economy. The IIP number measures the
industrial production for the period under review, usually a month, as against the reference
period. IIP is a key economic indicator of the manufacturing sector of the economy. There is a
lag of six weeks in the publication of the IIP index data after the reference month ends. IIP index
is currently calculated using 2011-2012 as the base year.
The IIP data is compiled and published by CSO every month. CSO or Central Statistical
Organisation operates under the Ministry of Statistics and Programme Implementation (MoSPI).
The factory production data (IIP) is used by various government agencies such as the Ministry of
Finance, the Reserve Bank of India (RBI), private firms and analysts, among others for analytical
purposes. The data is also used to compile the Gross Value Added (GVA) of the manufacturing
sector in the Gross Domestic Product (GDP) on a quarterly basis
IIP Index Components:

 Mining, manufacturing, and electricity are the three broad sectors in which IIP
constituents fall.
 The relative weights of these three sectors are 77.6% (manufacturing), 14.4% (mining)
and 8% (electricity).
 Electricity, crude oil, coal, cement, steel, refinery products, natural gas, and fertilizers
are the eight core industries that comprise about 40 per cent of the weight of items
included in the IIP.
Basket of products
There are 6 sub-categories:

 Primary Goods (consisting of mining, electricity, fuels and fertilisers)

 Capital Goods (machinery items)
 Intermediate Goods (yarns, chemicals, semi-finished steel items, etc.)
 Infrastructure Goods (paints, cement, cables, bricks and tiles, rail materials, etc.)
 Consumer Durables (garments, telephones, passenger vehicles, etc.)
  Consumer Non-durables (food items, medicines, toiletries, etc.)

COMPARITIVE ANALYSIS OF IIP

MONTHS JUL AUG SEPT OCT NOV DEC JAN FEB MAR APR MAY2 JUN
20 20 20 20 20 20 21 21 21 21 1 21
GROWTH -10.5 -7.1 1 4.5 -1.6 2.2 -0.6 -3.4 24.1 133.4 28.6 13.6
%

JULY 2020
Industrial production in India shrank 10.4 percent year-on-year in July of 2020, following a
downwardly revised 15.8 percent fall in June and compared to forecasts of an 11.5 percent
drop. It marks the fifth straight month of falling industrial output due to the coronavirus
pandemic and a prolonged lockdown. Manufacturing went down 11.1 percent, mining sank 13
percent and electricity output declined 2.5 percent. Considering April to July, industrial output
plunged 29.2 percent.
AUGUST 2020
India's industrial production slumped 8.0 percent from a year earlier in August 2020, following a
revised 10.8 percent tumble in the previous month and compared to market expectations of a
7.5 percent contraction. Output declined for all sectors: manufacturing (-8.6 percent vs -11.6
percent in July); mining (-9.8 percent vs -12.8 percent); and electricity (-1.8 percent vs -2.5
percent).
SEPTEMBER 2020
India's industrial production rose 0.2 percent over a year earlier in September 2020, after falling
a downwardly revised 7.4 percent in the previous month and beating market expectations of a
2 percent contraction. It was the first increase in industrial production in seven months, mainly
due to a rebound in mining (1.4 percent vs -9 percent in August); and electricity (4.9 percent vs
-1.8 percent). Additionally, manufacturing production went down 0.6 percent, less than a 7.9
percent drop in August.
OCTOBER 2020
Industrial production in India jumped 3.6 percent year-on-year in October of 2020, following an
upwardly revised 0.5 percent rise in September and beating market forecasts of 1.1 percent. It
is the strongest gain since February, before the coronavirus hit, as more activities reopen after a
long lockdown. Manufacturing went up 3.5 percent, the first rise in eight months and electricity
output surged 11.2 percent. In contrast, mining shrank 1.5 percent.
NOVEMBER 2020
India's industrial production fell 1.9 percent from a year earlier in November 2020, after rising
an upwardly revised 4.2 percent in the previous month and compared with market expectations
of a 0.4 percent drop. Manufacturing production shrank 1.7 percent (vs 4.1 percent in October)
and mining output tumbled 7.3 percent (vs -1.3 percent in October), while electricity output
rose 3.5 percent (vs 11.2 percent in October).
DECEMBER 2020
India's industrial production rose 1.0 percent from a year earlier in December 2020, partially
recovering from a revised 2.1 percent decline in the previous month and easily beating market
expectations of a 0.2 percent contraction. Manufacturing production rebounded 1.6 percent (vs
-2.0 percent in November), led by basic metals output (4.2 percent vs 2.5 percent), chemicals
and chemical products (7.2 percent vs 0.2 percent), pharmaceuticals, medicinal chemical and
botanical products (6.8 percent vs -2.3 percent), motor vehicles, trailers and semi-trailers (5.4
percent vs -0.7 percent), and machinery and equipment n.e.c. (4.3 percent vs -5.7 percent). In
contrast, output fell for both coke and refined petroleum products (-0.7 percent vs -3.3
percent) and food products (-1.4 percent vs 7.8 percent
JANUARY 2021
India's industrial production dropped 1.6 percent from a year earlier in January 2021, reversing
an upwardly revised 1.6 percent growth in the previous month and missing market
expectations of a 0.9 percent increase. Manufacturing output shrank 2.0 percent (vs 2.1
percent in December), led by falls in production of coke and refined petroleum products (-0.5
percent vs -0.7 percent), food products (-2.6 percent vs -1.8 percent), pharmaceuticals,
medicinal chemical and botanical products (-11.5 percent vs 4.2 percent), motor vehicles,
trailers and semi-trailers (-0.9 percent vs 6.4 percent), and machinery and equipment (-7.6
percent vs 9.4 percent). By contrast, there were increases in production of basic metals (4.2
percent vs 5.7 percent) and chemicals and chemical products (3.1 percent vs 7 percent).
Elsewhere, mining output contracted 3.7 percent (vs -4.2 percent in December), while
electricity production rose 5.5 percent (vs 5.1 percent in December).
2021-03-12T12:17:00
FEBRUARY 2021
India's industrial output dropped 3.6 percent from a year earlier in February 2021, the most
since last August and compared with market expectations of a 3.0 percent decrease.
Manufacturing production shrank 3.7 percent (vs -1.3 percent in January), led by declines in
manufacture of basic metals (-4.8 percent vs 6.0 percent), coke and refined petroleum products
(-9.5 percent vs -0.5 percent), chemicals and chemical products (-1.8 percent vs 2.6 percent),
food products (-0.6 percent vs -3.3 percent), pharmaceuticals, medicinal chemical and botanical
products (-4.8 percent vs -8.0 percent), machinery and equipment n.e.c. (-1.9 percent vs -7.2
percent), and other non-metallic mineral products (-7.0 percent vs -6.1 percent). Meanwhile,
mining output was down 5.5 percent (vs -2.5 percent in January), while electricity output edged
0.1 percent higher (vs 5.5 percent in January)
MARCH 2021
India's industrial output surged 22.4 percent in March 2021 compared with the same month
last year when a strict lockdown was in place due to the coronavirus outbreak. It was the
largest increase in industrial activity on record, easily beating market expectations of a 17.6
percent jump, mainly boosted by a 25.8 percent advance in manufacturing output. Within
manufacturing, production rose for basic metals; chemicals & chemical products; food
products; pharmaceuticals, medicinal chemical & botanical products; vehicles; machinery &
equipment; and other non-metallic mineral products. By contrast, the manufacture of coke and
refined petroleum products continued to contract. Elsewhere, electricity production climbed
22.5 percent and mining output rose 6.1 percent
APRIL 2021
Industrial production in India surged 134.4 percent year-on-year in April of 2021, the biggest
increase ever, beating market forecasts of a 120 percent gain. A low base effect from last year is
weighing on the data as production fell at a record 57.3 percent in April 2020 when the majority
of the establishments were not operating and many units had no production due to the
coronavirus lockdown. Big rises this year were seen for manufacturing (197.1 percent), mining
(37.1 percent) and electricity (38.5 percent).
MAY 2021
India Industrial Production Rises Less than Expected. Industrial production in India rose 29.3
percent year-on-year in May of 2021, below market expectations of 32 percent as regional
lockdowns in most states to contain the second wave of the coronavirus pandemic hurt
activities. Manufacturing production advanced 34.5 percent, led by motor vehicles, trailers and
semi-trailers (208.2 percent) and textiles (165.2 percent). Also, output rose for mining (23.3
percent) and electricity (7.5 percent)
JUNE 2021
Industrial production in India rose 13.6 percent year-on-year in June of 2021, slightly above market
expectations of 13.5 percent. Manufacturing production advanced 13 percent, led by basic metals (24
percent), coke and refined petroleum products (5.4 percent) and motor vehicles, trailers and semi-
trailers (61.5 percent). Also, output rose for mining (23.1 percent) and electricity (8.3 percent).
INFLATION
Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the
rate at which the decline in purchasing power occurs can be reflected in the increase of an average price
level of a basket of selected goods and services in an economy over some period of time. The rise in the
general level of prices, often expressed as a percentage, means that a unit of currency effectively buys
less than it did in prior periods.

Inflation can be contrasted with deflation, which occurs when the purchasing power of money increases
and prices decline.

While it is easy to measure the price changes of individual products over time, human needs extend
much beyond one or two such products. Individuals need a big and diversified set of products as well as
a host of services for living a comfortable life. They include commodities like food grains, metal, fuel,
utilities like electricity and transportation, and services like healthcare, entertainment, and labor.

What is Inflation?

While it is easy to measure the price changes of individual products over time, human needs extend
much beyond one or two such products. Individuals need a big and diversified set of products as well as
a host of services for living a comfortable life. They include commodities like food grains, metal, fuel,
utilities like electricity and transportation, and services like healthcare, entertainment, and labor.

Inflation aims to measure the overall impact of price changes for a diversified set of products and
services, and allows for a single value representation of the increase in the price level of goods and
services in an economy over a period of time.

As a currency loses value, prices rise and it buys fewer goods and services. This loss of purchasing power
impacts the general cost of living for the common public which ultimately leads to a deceleration in
economic growth. The consensus view among economists is that sustained inflation occurs when a
nation's money supply growth outpaces economic growth.

To combat this, a country's appropriate monetary authority, like the central bank, then takes the
necessary measures to manage the supply of money and credit to keep inflation within permissible
limits and keep the economy running smoothly.

Inflation is measured in a variety of ways depending upon the types of goods and services considered
and is the opposite of deflation which indicates a general decline occurring in prices for goods and
services when the inflation rate falls below 0%.

Causes of Inflation
An increase in the supply of money is the root of inflation. Money supply can be increased by the
monetary authorities either by printing and giving away more money to the individuals, by legally
devaluing (reducing the value of) the legal tender currency, more (most commonly) by loaning new
money into existence as reserve account credits through the banking system by purchasing government
bonds from banks on the secondary market. In all such cases of money supply increase, the money loses
its purchasing power. The mechanisms of how this drives inflation can be classified into three types:
demand-pull inflation, cost-push inflation, and built-in inflation.

1. Demand-Pull Effect

Demand-pull inflation occurs when an increase in the supply of money and credit stimulates overall
demand for goods and services in an economy to increase more rapidly than the economy's production
capacity. This increases demand and leads to price rises.

With more money available to individuals, positive consumer sentiment leads to higher spending, and
this increased demand pulls prices higher. It creates a demand-supply gap with higher demand and less
flexible supply, which results in higher prices.

2. Cost-Push Effect

Cost-push inflation is a result of the increase in prices working through the production process inputs.
When additions to the supply of money and credit are channeled into a commodity or other asset
markets and especially when this is accompanied by a negative economic shock to the supply of key
commodities, costs for all kinds of intermediate goods rise.

These developments lead to higher costs for the finished product or service and work their way into
rising consumer prices. For instance, when the expansion of the money supply creates a speculative
boom in oil prices the cost of energy of all sorts of uses can rise and contribute to rising consumer
prices, which is reflected in various measures of inflation.

3. Built-in Inflation

Built-in inflation is related to adaptive expectations, the idea that people expect current inflation rates
to continue in the future. As the price of goods and services rises, workers and others come to expect
that they will continue to rise in the future at a similar rate and demand more costs or wages to
maintain their standard of living. Their increased wages result in higher cost of goods and services, and
this wage-price spiral continues as one factor induces the other and vice-versa.

Types of Price Indexes

Depending upon the selected set of goods and services used, multiple types of baskets of goods are
calculated and tracked as price indexes. Most commonly used price indexes are the Consumer Price
Index (CPI) and the Wholesale Price Index (WPI).

1. The Consumer Price Index

The CPI is a measure that examines the weighted average of prices of a basket of goods and services
which are of primary consumer needs. They include transportation, food, and medical care. CPI is
calculated by taking price changes for each item in the predetermined basket of goods and averaging
them based on their relative weight in the whole basket. The prices in consideration are the retail prices
of each item, as available for purchase by the individual citizens.

Changes in the CPI are used to assess price changes associated with the cost of living, making it one of
the most frequently used statistics for identifying periods of inflation or deflation. In the U.S., the Bureau
of Labor Statistics reports the CPI on a monthly basis and has calculated it as far back as 1913.2

2. The Wholesale Price Index

The WPI is another popular measure of inflation, which measures and tracks the changes in the price of
goods in the stages before the retail level. While WPI items vary from one country to other, they mostly
include items at the producer or wholesale level. For example, it includes cotton prices for raw cotton,
cotton yarn, cotton gray goods, and cotton clothing.

Although many countries and organizations use WPI, many other countries, including the U.S., use a
similar variant called the producer price index (PPI).

3. The Producer Price Index

The producer price index is a family of indexes that measures the average change in selling prices
received by domestic producers of intermediate goods and services over time. The PPI measures price
changes from the perspective of the seller and differs from the CPI which measures price changes from
the perspective of the buyer.4

In all such variants, it is possible that the rise in the price of one component (say oil) cancels out the
price decline in another (say wheat) to a certain extent. Overall, each index represents the average
weighted price change for the given constituents which may apply at the overall economy, sector, or
commodity level.

The Formula for Measuring Inflation

The above-mentioned variants of price indexes can be used to calculate the value of inflation between
two particular months (or years). While a lot of ready-made inflation calculators are already available on
various financial portal and websites, it is always better to be aware of the underlying methodology to
ensure accuracy with a clear understanding of the calculations. Mathematically,

Percent inflation rate = (Final CPI Index Value/Initial CPI Value)*100

Controlling Inflation
A country’s financial regulator shoulders the important responsibility of keeping inflation in check. It is
done by implementing measures through monetary policy, which refers to the actions of a central bank
or other committees that determine the size and rate of growth of the money supply.

Hedging Against Inflation

Stocks are considered to be the best hedge against inflation, as the rise in stock prices are inclusive of
the effects of inflation. Since additions to the money supply in virtually all modern economies occur as
bank credit injections through the financial system, much of the immediate effect on prices happens in
financial assets that are priced in currency, such as stocks.

Additionally, special financial instruments exist which one can use to safeguard investments against
inflation. They include Treasury Inflation Protected Securities (TIPS), low-risk treasury security that is
indexed to inflation where the principal amount invested is increased by the percentage of inflation.

One can also opt for a TIPS mutual fund or TIPS-based exchange traded fund (ETFs). To get access to
stocks, ETFs, and other funds that can help to avoid the dangers of inflation, you'll likely need a
brokerage account. Choosing a stockbroker can be a tedious process due to the variety among them.

Gold is also considered to be a hedge against inflation, although this doesn't always appear to be the
case looking backward.

Is Inflation Good or Bad?

Too much inflation is generally considered bad for an economy, while too little inflation is also
considered harmful. Many economists advocate for a middle-ground of low to moderate inflation, of
around 2% per year.

Generally speaking, higher inflation harms savers because it erodes the purchasing power of the money
they have saved. However, it can benefit borrowers because the inflation-adjusted value of their
outstanding debts shrinks over time.

Stagflation
Stagflation is characterized by slow economic growth and relatively high unemployment—or economic
stagnation—which is at the same time accompanied by rising prices (i.e. inflation). Stagflation can be
alternatively defined as a period of inflation combined with a decline in gross domestic product (GDP).

Stagflation led to the emergence of the misery index. This index, which is the simple sum of the inflation
rate and unemployment rate, served as a tool to show just how badly people were feeling when
stagflation hit the economy.

What Causes Stagflation?

Stagflation is characterized by slow economic growth and relatively high unemployment—or economic
stagnation—which is at the same time accompanied by rising prices (i.e. inflation). While many theories
abound, the consensus is that stagflation occurs when money supply is expanding while supply is being
constrained. For example, if a government prints currency, which would increase the money supply and
create inflation, while raising taxes, which would slow economic growth, the end result would be
stagflation.

Why Is Stagflation Bad?

Conceptually, stagflation is a contradiction as slow economic growth would likely lead to an increase in
unemployment but should not result in rising prices. This is why this phenomenon is so dangerous. An
increase in the unemployment level results in a decrease of consumer spending power. If you tack on
runaway inflation, that means that what money consumers do have is losing value as time goes by.
There is less money to spend and all money being worth less and less.

What Is the Cure for Stagflation?

There is no definitive cure for stagflation. The consensus amongst economists is that productivity has to
be increased to the point where it would lead to higher growth without additional inflation. This would
then allow authorities to tighten monetary policy to reign in the rampant-inflation component of
stagflation. That is easier said than done, so the key to preventing stagflation is to be extremely
proactive in avoiding it.