Rau’s IAS- B K Reddy sir

INFLATION
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.

TYPES OF INFLATION
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)
Difference between WPI and CPI
Criteria Wholesale Price Index Consumer Price Index (CPI)
Level Measures Inflation at Measures Inflation at Retail
Wholesale level level
Who Calculates? Office of Economic National Statistical Office,
Advisor, Ministry of MoSPI
Commerce and
Industry
Base year 2011-12 2012
Released on 14th of Every Month 12th of Every Month
Number of Items 697 299
covered
Categories and  Primary Articles:  Food and beverages (45.86%)
their respective (22.6%)  Pan, Tobacco and Intoxicants
weightages  Manufactured (2.38%)
products (64.2%)  Clothing and Footwear
 Fuel and Power (6.53%)
(13.2%)  Housing (10%)
 Fuel and Light (6.84%):
Electricity, LPG, Kerosene
etc. (Does not include Petrol
and Diesel)
  Miscellaneous- Education,
Healthcare, Transportation
and Communication etc.
(28.32%)
Weightage given to WPI-Food Index Consumer Food Price Index
Food Articles (24%): Food articles (CFPI): (39%): Out of 12 sub-
from "Primary groups contained in 'Food and
Articles" and Beverages' group, CFPI is
"Manufactured Food based on ten sub-groups,
Product". excluding 'Non-alcoholic
beverages' and 'Prepared
meals, snacks, sweets etc. (For
Details, refer to Rau’s
Economic Survey Video)
Impact of increase Less impact on WPI as Larger impact on CPI
in Food items compared to CPI
Weightage of Fuel Included in separate Weightage (~8%): Included in
and Power category of Fuel and (a) category of Fuel and light
Power (13.2%) and (b) Category of
Transportation and
Communication (Fuel for
Transportation)
Highest Weightage Manufactured products Food and Beverages (45.9%)
(64.2%)
Services included No Yes
Indirect Taxes No Yes
Included?
Targeted by RBI? No Yes. The RBI is required to
maintain CPI rate of inflation
of 4% with a deviation of 2%.
RECENT TRENDS IN CPI RATE OF INFLATION

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.
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-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.
 FOOD PRICE 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 Fixed basket All the Goods and Services produced
Covered of Goods within India.
and Services
consumed
by people
Imported Yes. No.
Goods
Covered
Basket of Remains Changes.
Goods Same
Weightage of Explicitly Market value of Goods and Services
different defined
Goods
Frequency Monthly Quarterly.

HEADLINE V/S CORE INFLATION

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 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.
WHAT TO TARGET: HEADLINE OR CORE INFLATION?
Presently, the RBI targets CPI headline rate of inflation and not the Core
Inflation. In this regard, the Economic Survey 2020-21 has highlighted that
sole focus on CPI headline rate of Inflation may not be appropriate on account
of number of reasons. Accordingly, it has recommended that a greater focus on
core inflation is warranted.
REASONS
Firstly, Headline inflation may take place due to volatility in prices of Crude
oil and Food commodities, over which RBI has no control. For example, failure
of monsoons, lack of cold chain infrastructure, supply side bottlenecks etc.
usually lead to increase in Food prices.
Secondly, most of the time inflation in Food commodities is transitory and may
not require any policy action by the RBI
Thirdly, if the RBI tries to control inflation due to volatility in prices of food
commodities, it can prove to be counterproductive. For example, to control
inflation, rate of interest would increase--> Decline in Investment and
Consumption Expenditure--> Economic Slowdown.
Fourthly, to measure inflation correctly, weightage must be assigned to
different categories of commodities depending upon their share in the
household expenditure. Higher the share, higher should be weightage. The
share of food commodities in the household expenditure has declined since
2011-12, yet the CPI gives a weightage of almost 45% to the food commodities.

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).
Base effect:
Rate of Inflation in the current year depends on rate of inflation in the
Previous year.
Rate of Inflation =
 B K REDDY SIR

(Prices in current month - Prices in corresponding month of previous

year/ Prices in
Corresponding month of Previous year) * 100.
Scenario 1: Higher value of Base/Denominator  Lower Rate of Inflation
Scenario 2: Lower value of Base/Denominator  Higher Rate of 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.
 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).

REVISION IN INFLATION INDEX LINKED TO MGNREGA

Government has planned to link the MGNREGA Wages to an updated inflation
Index based on the recommendation of Mahendra Dev Verman Committee.
Currently, MGNREGA wages are linked to CPI-AL. Now the Government is
planning to link the MGNREGA wages either to CPI-AL or CPI-Rural,
whichever is higher in a particular state

IMPORTANT COMMITTEES RELATED TO INFLATION

Committee Recommendation
B N Goldar Developing PPI for
Committee India
Ramesh Chand Roadmap for switch
Committee (Niti over from WPI to PPI
Aayog)
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Urjit Patel Committee Recommended

Monetary Policy
Committee
Mahendra Dev Linking MGNERGA
Verman Committee to CPI-RL
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TRENDS IN INFLATION INDICES

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DIVERGENCE BETWEEN WPI AND CPI

Between June 2019 and February 2021, wholesale inflation was lower than
retail inflation, while between March 2021 and December 2021, wholesale
inflation remained above the retail inflation. WPI inflation during the current
year was higher than the CPI but there was also a significant widening of the
divergence.

Divergence between WPI and CPI

Between June 2019- Feb 2021 WPI < CPI
Between Mar 2021 – Dec 2021 WPI > CPI
Why has CPI Inflation lowered? Why WPI Inflation has increased?
 Decline in Inflation in Food and  Low Base Effect
Beverages which accounts for  Increase in Prices of Primary
46% weightage in CPI Articles, Fuel and Power and
 Decline in Vegetable Prices, Manufactured Products
Pulses etc.
 Supply side measures taken by Cost-push Inflation due to supply side
the Government bottlenecks and higher international
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 Reduction in Import duties on prices in metals, raw materials, Fuel

Pulses and Edible Oils etc.
 Buffer stock of Onion and Pulses
 Bringing Soya meal under
Essential Commodities Act, 1955
Main Drivers of Inflation in 2021- Main Drivers of Inflation in 2021-22
22 Fuel and Power (Weightage of 13% in
Fuel and light WPI)
Transportation Manufactured Products (Weightage
Low Weightage of 8% in CPI of 64% in WPI)
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SUPPLY SIDE MEASURES TAKEN BY GOVERNMENT

Creating a buffer stock of Pulses and Onion under Price stabilisation Fund
(PSF): The Government of India approved the creation of a Price Stabilization
Fund (PSF) in 2015 with a corpus of Rs.500 crores as a Central Sector Scheme.
Initially the fund was proposed to be used for market interventions for onion
and potato only and pulses were added subsequently.
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This scheme is implemented by Ministry of Consumer Affairs, Food & Public

Distribution. The PSF will be maintained as a Central Corpus Fund by Small
Farmers Agribusiness Consortium (SFAC).
Import Policy: Reduction in the import duties on Pulses, Edible oils to boost
domestic availability.
Essential Commodities Act: Government has notified an Order the Essential
Commodities Act to declare ‘Soya Meal’ as an Essential Commodities up to
30th June, 2022 by amending the Schedule of the Essential Commodities Act,
1955. Stock limit on Soya Meal has been imposed for a period from 23rd
December, 2021 up to 30th June, 2022.
Perishable essential commodities: For perishables, Operations Green scheme
was launched in November 2018. The scheme has later been expanded from
TOP (Tomato, Onion, Potato) to TOTAL (41 perishables). Expansion of the
scheme has resulted in widening the impact in terms of the production clusters
and beneficiaries covered.

GLOBAL INFLATION (PERSINALITY TEST IMPORTANT )

The Global economy has started recovering from the slowdown caused due to
Covid-19 pandemic. However, it has started facing the challenge of rising
inflation. The inflation in USA touched 7.0 per cent in December 2021, the
highest since 1982. While in the UK it hit a nearly 30 years high of 5.4 per cent
in December 2021 mainly on account of rising food prices
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Reasons for Global Inflation

Demand-Pull Inflation Cost Push Inflation
 Faster Economic Recovery  Global Supply chain disruptions
post Covid-19 has led to surge such as Semiconductor shortages
in demand for raw materials  Increase in metal prices (Copper,
 Increase in Pent-up demand Iron ore. Nickel, Steel etc.)
 Fiscal Stimulus measures  Increase in Energy Prices (Gas,
adopted by the Central Bank Coal and Electricity)
 Higher demand for certain  Container shortage and rising
electronic goods such as freight costs
laptops and Phones  Rise in food commodities