INFLATION NOTES

BASIC TERMS RELATED TO INFLATION

Inflation refers to a sustained rise in general level of prices over a period of time in the economy.
This results in fall in the value of money i.e., purchasing power of money over a period of time.

Deflation: Refers to a fall in the general level of prices over a period of time. (Negative rate of
inflation)

Disinflation: slowing down of rate of inflation

Skewflation: General Price rise over a sustained period of time is skewed to one or a small group
of commodities

Galloping inflation: Very high inflation running in the range of double-digit or triple–digit (20%,
200% per year). It is also known as hopping inflation, jumping inflation, and running or runaway
inflation.

Hyperinflation: Hyperinflation is large and accelerating inflation, when prices rise by more than
50% a month. It is very rare. Examples of hyperinflation include Germany in the 1920s, Zimbabwe
in the 2000s, and Venezuela in the 2010s.

Creeping Inflation: Also called mild inflation, it refers to gradual rise in price levels along time.
(Good for the economy)

Bottleneck Inflation: Also called as structural inflation, it occurs when supply falls drastically and
the demand remains at the same level.

Inflation Tax: It refers to the penalty for holding cash at a time of high inflation due to erosion of
value of money.

PHILIPS CURVE
Establishes the inverse relation between inflation and unemployment. Accordingly as levels of
unemployment decrease, inflation increases

Stagflation: It is a situation characterised by slow economic growth and high unemployment

(stagnation) accompanied by inflation.

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►Types of Inflation
NOTES
Based on its origin, inflation is categorised into demand-pull and cost-push inflation.

Cost-push Inflation: Caused by rise in prices of factors of production such as increased cost of
raw materials, electricity, rent, labour etc.

Demand-pull Inflation: It occurs in a situation where demand increases due to excess money
supply with people without increase in supply level. In other words it occurs when too much
money chasing too few goods.

►Measures of Inflation

The rate of inflation is measured on the basis of price indices. Price index measures the average
level of prices and not that of a single good. The Inflation is measured on a point-to-point basis i.e.,
prices in the current month are compared with the prices in the corresponding month of the
previous year.

►WHOLESALE PRICE INDEX (WPI) and CONSUMER PRICE INDEX (CPI)

►WPI Food Index: Sub-index of WPI; It is combination of the food articles from the Primary
Articles basket, and the food products from the Manufactured Products basket.

►Consumer Food Price Index (CFPI): The base year and methodology of calculation of CFPI is
similar to CPI. However, in order to calculate CFPI, we take into account only the category of Food
and Beverages. Within this category, there are 12 sub-groups such as cereals, Meat, fish, Fruits etc.

Out of these 12 sub-groups, CFPI is based on ten sub-groups, excluding ‘Non-alcoholic beverages’
and ‘Prepared meals, snacks, sweets etc.’.

►Other Variants of CPI

Different indices used to measure price level at multiple consumer levels include

1. CPI for industrial workers (CPI-IW) – Base year has been revised from 2001 to 2016.

2. CPI for agricultural labourers (CPI-AL) – Base year 1986-87.

3. CPI for rural labourers (CPI-RL) – Base year 1986-87.

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Note: CPI-IL, AL and RL are published by Labour Bureau, Ministry of Labour and Employment. The
MGNREGA wages are presently linked to CPI-AL and the government's proposal is to link it to CPI- NOTES
RL. CPI-IW is used for calculation of Dearness Allowance.

►Services Price Index (SPI)

Published by the Office of Economic Advisor under Ministry for Commerce and Industry. Measures
separately inflation in services such as Railways, Postal, Banking, Aviation, Insurance, Telecom etc.

►Producer Price Index: Measures price changes that a producer faces on primary, Intermediate
and finished goods and services upon selling goods and services. Hence, it measures the average
change in the price of goods and services either as they leave the place of production or as they
enter the production process.

The primary difference between the WPI and the PPI is, in addition to the coverage, that the WPI
reflects changes in the average cost of production including mark-ups and taxes, while the PPI
measures price changes of transacted goods at the gate excluding taxes.

►RESIDEX: Measures the price changes in residential real estate. Developed by National Housing
Bank (NHB). Two housing price indices i.e., HPI@ Assessment Prices and HPI@ Market Prices.

►All India House Price Index (HPI)

 Released by Reserve Bank of India (published quarterly).

 Base year: 2010-11

 Based on the transaction level data received from housing registration authorities in ten major
cities (viz., Ahmedabad, Bengaluru, Chennai, Delhi, Jaipur, Kanpur, Kochi, Kolkata, Lucknow,
and Mumbai).

►New Wage rate Index (WRI)

Purpose: Economic indicator which measures relative changes in the wage level in selected
industries. It can be considered like Index of Industrial Production (IIP) which tracks changes in the
volume of Industrial production.

Enhanced Coverage: The new series seeks to cover 700 occupations and makes the index more
representatives, expanding the number of industries, sample size and the weightage of industries.
While the previous series covered 21 industries, the new one covers 37, including 30 from the
manufacturing sector and three each from the mining and plantation sectors.

Modifications:

 Under the manufacturing sector, 16 industries such as synthetic textiles, publishing, footwear,
petroleum, drugs and medicines, have been added.

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 Under plantation sector, Tea, Coffee and Rubber have been retained with enhanced coverage.
NOTES
 Under mining sector, oil mining industry has been introduced in the basket in place of mica
mines industry

Benefits of new series: Provide valuable insights to determine minimum wages and national floor
wage policy.

►Food Prize Index: Published by FAO. FFPI tracks the international prices of the most commonly
traded food commodities.

Commodity Groups Covered: 5 commodity groups which include Meat, Dairy, Cereals, Vegetable
oil and Sugar.

Weightage Assigned: Each of the Commodity groups is assigned a weightage in proportion to its
share in the global trade in agricultural commodities.

Base Year: A three-year period is chosen to minimize the impact of variation in both
internationally traded prices and quantities. Earlier, the Base year was 2002-04, but now it has
been changed to 2014-16.

►Baltic Dry Index: Published by London- based Baltic Exchange. The index provides an
assessment of the price of moving the major raw materials by sea. The Baltic Dry Index takes into
account the freight rates for bulk commodities such as coal, iron ore and grain.

Importance of Baltic Dry Index: If the Index increases, it means that the freight rates have
increased which indicate higher demand for raw materials such as Coal, Iron-ore etc. and hence
higher economic growth. Similarly, if the index decreased, it would point to decreased economic
activity and hence lower economic growth in future.

Other Indices for tracking Freight rates: The Baltic Dirty Tanker Index tracks freight rates for
crude oil and the Baltic Clean Tanker Index tracks freight rates for petroleum products.

►GDP Deflator

Measure of inflation calculated as the ratio of GDP at current prices to GDP at constant prices.

Criteria CPI GDP Deflator

Commodities Covered Fixed basket of Goods and All the Goods and Services
Services consumed by people produced within India.

Imported Goods Covered Yes. No.

Basket of Goods Remains Same Changes.

Weightage of different Explicitly defined Market value of Goods and

Goods Services

Frequency Monthly Quarterly.

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►Headline v/s Core Inflation
NOTES
The headline inflation simply refers to the inflation in the CPI (or WPI) covering all the categories of
goods and services. On the other hand, the core inflation excludes the volatile categories such as
food and fuel in order to measure the increase in the prices of goods and services. Hence, a drastic
fall in the food and fuel prices can bring down the headline inflation by a to a large extent.
However, the core inflation may remain unaffected.

►Base Effect: The base effect refers to the impact of the rise in price level (i.e. last year’s inflation)
in the previous year over the corresponding rise in price levels in the current year (i.e., current
inflation).

►Cobweb Phenomenon: Explains large scale fluctuations in the prices of Pulses in Indian Market.
If prices were higher in the previous year, more number of farmers would sow pulses in the
current year leading to its over-production and subsequent decline in the prices. The lower prices
in the current year disincentivise the farmers from growing crop in the next cropping season
leading to under-production and subsequent increase in the prices.

►Effects of Inflation

Creditors and debtors: Inflation represents degradation of value of money. Thus it adversely
impacts those who lend money (creditors) and benefits those who borrow money (debtors)

Rate of interest: Real rate of interest (nominal rate of interest minus inflation) decreases due to
rise in inflation.

E.g.: Suppose bank A gives loan at 10% interest. Now, inflation in the economy is 5%. The actual
rate of interest to be paid by borrowers will be only 5% (10%-5%).

Investment: Moderate rate of Inflation (4%) indicates higher demand and thus leads to an
increase in investment in the economy. However, very high rate of Inflation could lead to macro-
economic instability and thus lead to lower investments.

Savings: An increase in inflation would mean that holding money as savings is not a good option.

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Tax Liability: Increase in inflation increases the direct tax liability of the individuals. Indirect tax
liability also increases due to inflation. NOTES
Exchange rate: Inflation leads to depreciation of rupee.

►Price Stabilization Fund: Procurement of Onion, Pulses and Tomato from farmers and made
available at a more reasonable price to the consumers. Implemented by Ministry of Consumer
Affairs, Food & Public Distribution.

►Operation Greens (TOP to TOTAL): Protect the growers of fruits and vegetables from making
distress sale. Recently, the ambit of scheme was extended from Tomato, Onion and Potato (TOP)
to all fruits and Vegetables (TOTAL). Implemented by Ministry of Ministry of Food Processing
Industries (MoFPI).

►Important Committees related to Inflation

Committee Recommendation

B N Goldar Committee Developing PPI for India

Ramesh Chand Committee (Niti Aayog) Roadmap for switch over from WPI to PPI

Urjit Patel Committee Recommended Monetary Policy Committee

Mahendra Dev Verman Committee Linking MGNERGA to CPI-RL

PREVIOUS YEAR QUESTIONS

Q1. In India, which one of the following is (d) Creation of new money to finance
responsible for maintaining price a budget deficit
stability by controlling inflation?
Q3. With reference to Indian economy,
(Prelims 2022)
demand- pull inflation can be caused/
(a) Department of Consumer Affairs increased by which of the following?
(Prelims 2021)
(b) Expenditure Management
Commission 1. Expansionary policies

(c) Financial Stability and 2. Fiscal stimulus

Development Council
3. Inflation-indexing wages
(d) Reserve Bank of India
4. Higher purchasing power
Q2. Which one of the following is likely to
5. Rising interest rates
be the most inflationary in its effects?
(Prelims 2021) Select the correct answer using the
code given below.
(a) Repayment of public debt
(a) 1, 2 and 4 only
(b) Borrowing from the public to
finance a budget deficit (b) 3, 4 and 5 only

(c) Borrowing from the banks to (c) 1, 2, 3 and 5 only

finance a budget deficit (d) 1, 2, 3, 4 and 5

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Q4. Consider the following statements: Q5. With reference to inflation in India,
(Prelims 2020) which of me following statements is NOTES
correct? (Prelims 2015)
1. The weightage of food in
Consumer Price Index (CPI) is (a) Controlling the inflation in India is
higher than that in Wholesale Price the responsibility of the
Index (WPI). Government of India only

2. The WPI does not capture changes (b) The Reserve Bank of India has no
in the prices of services, which CPI role in controlling the inflation
does.
(c) Decreased money circulation helps
3. Reserve Bank of India has now in controlling the inflation
adopted WPI as its key measure of
(d) Increased money circulation helps
inflation and to decide on changing
in controlling the inflation
the key policy rates.
Q6. Which of the following brings out the
Which of the statements given above
'Consumer Price Index Number for
is/are correct?
Industrial Workers?
(a) 1 and 2 only
(a) The Reserve Bank of India
(b) 2 only
(b) The Department of Economic
(c) 3 only Affairs

(d) 1, 2 and 3 (c) The Labour Bureau

(d) The Department of Personnel and

Training

ANSWER KEYS

1 2 3 4 5 6
d d a a c c