MacroEconomics for Managers

Measures of Inflation
Headlines:

https://tradingeconomics.com/india/inflation-cpi

Related Last Previous Unit Reference

Inflation Rate 7.79 6.95 percent Apr 2022

Consumer Price 170.10 167.70 points Apr 2022

Index CPI

GDP Deflator 160.10 146.10 points Dec 2022

Food Inflation 8.38 7.68 percent Apr 2022

In the news!...moneycontrol

Indian Rupee at a new low: 4 factors-

- Hike in oil prices( India meets 85% of its fuel
needs through imports)
- Foreign capital outflows- discuss later
- Fed rate hike worries-> increase the return on
dollar assets, leading to flight from India and
emerging markets.- discuss later
- domestic and global inflation.
Inflation: a building bloc

 A building bloc for Monetary Policy

Recommendations…like?

 Simply because it measures the cost of

living.
Objective of measuring inflation

 They are of use in Monetary Policy; and

Monetary policy recommendations come with
a lag!
 The policy makers ought to know which of
the price changes are transitory and which of
them are permanent; and monetary policy
addresses the permanent changes which are
critical.
 That’s the reason why central banks use ‘core’
inflation.
 Measures of ‘core’ inflation are designed to
filter transitory price movements by eliminating
volatile price movements of items like- food,
energy-and identifying the underlying trend in
inflation.
 Headline inflation: is the WPI/CPI in India; CPI
in most other countries.
CPI remains…

 The measure of cost of Living and so contin-

ues to be given primary importance.
 Core inflation is simply a guide for monetary
policy- to target/control inflation, manage
money supply, price stability, growth, etc.
Measures of Inflation

 CPI : Consumer Price Index

- is a weighted average of prices of several
goods and is presented in the form of Index
Numbers. It signals the change in prices
facing the consumers.
 WPI : Signals the changes in prices facing
the producer.
 GDP Deflator: Signals overall national price
changes.
Some HH surveys conducted in India-
Basket consumed by a typical
consumer

 NSHIE: National Survey of Household Income

and Expenditure ; also called ‘Living in India’
survey.
Conducted by NCAER- very detailed and
insightful. Last conducted in 2011-12
 NSSO Surveys: National Sample Survey
Organization Surveys; diverse socio-
demographic data pertaining to conditions
under which the HHs live. Normally conducted
once in about 10 years.
Some more Surveys

Consumer Pyramid Household Survey.

Note that it is conducted thrice every
year(!); large panel of sample households
surveyed repeatedly over time.
Conducted by CMIE.
CPI

 Measures the overall cost of goods and

services bought by a typical consumer.
 Its calculation:

- Fix the basket and set their weights ( the

quantities of the goods in the basket). For eg, 4
Kgs of Wheat; 2 Kgs of Rice; 15 l of Milk; etc.
-Find the prices
- Compute the basket’s cost for different years.
CPI

 Choose the base year compute the index

Designate one year as the base year- the
benchmark against which other years are
compared.
 Then computed CPI as follows:
CPI = [Price of the basket of good and services
in the current year / price of the basket in the
base year] * 100.
Example

 Fix the basket: Consider only two

commodities: Rice and Milk.

2015 2016 2017

Rice/kg 20 30 35
Milk/ litre 20 25 30

Given these observed

prices, what is the
‘inflation’?
Example

 Fix the basket: Consider only two

commodities: Rice and Milk.
 Fix the weights: the quantities are Rice 15
Kgs; and Milk 40 litres.
2015 2016 2017
Rice/kg 20 30 35
Milk/ litre 20 25 30
Example
2015 2016 2017
Rice/kg 20 30 35
Milk/ litre 20 25 30
 Basket with Weights Rice 15 Kgs; Milk 40 litres
 Compute the basket’s cost:

2015: (Rs 20*15)+(Rs 20*40) = Rs 1100 Now? Is

it an
2016: (Rs 30*15)+(Rs 25*40) = Rs 1450 ‘index’?
2017: (Rs 35*15) +(Rs 30 * 40) = Rs 1725
Example

The final step: Choose the base year and

compute the index:
Let’s fix 2015 as the base year.
Compute the Index:
2015:(1100/1100) * 100= 100
2016: (1450/1100)*100= 131.8
2017: (1725/1100)*100 =156.8
Another method

 In the earlier method, we took the quantities

consumed in the base year as weights.
 Now we can also find the weights as:

First, find out the total expenditure in the base

year.ie Rs 1100.
Then find out the expenditure on each item in
the base year: Rs 300 on Rice; Rs 800 on Milk.
Then, find the share of each in the total:
300/1100= .27 ; 800/1100=.73
Another method

That is the base year ‘shares’: .27; .73 Note:

the sum of the weights must add upto 1.
We further assume that the proportionate
shares do not change.
Then we compute the ‘price relatives’ ie divide
the current Price of each item with the base
year price of each item.
Another Method

 Finally, we multiply each of the price relatives

by its weight( which we got), add them all up,
and we have the………….
CPI
WPI- Wholesale Price Index

 The points of difference are:

- The basket consists of Producer goods and
so the basket is much larger and so, the
weights are different from the CPI.
- The WPI consists of only goods, no services.
- WPI takes into consideration wholesale
prices; while CPI takes only retail prices.
 Points of commonality:

-In both the indices, the weights are constant.

The common formula

 Both the indices are fundamentally based on :

Ʃptq0 / Ʃp0q0
Where ‘p’ stands for price; ‘q’ stands for
quantity; and the subscripts ‘t’ and ‘0’stand for
current year and base year respectively.
MOSPI- Manual of Compilation of index numbers
of wholesale prices in India
CPI goals

 Is to measure the ‘cost of living’.

Problems:
- a ‘substitution bias’.
- Introduction of new goods. An increase in
‘variety’ makes the rupee more valuable!
And yet, in CPI, we keep the basket fixed!
GDP Deflator

 [ Nominal GDP / Real GDP ] * 100

 Nominal GDP is Current year Quantities(qt)
valued at Current year prices ( pt);
Real GDP is Current year Quantities(qt)
valued at base year prices (p0).
 The GDP Deflator reflects current year prices
relative to the base year prices.
Straight away, what is the difference between
GDP Deflator and CPI?
Differences between GDP Deflator
and CPI
 1. CPI = Ʃptq0/Ʃp0q0
 GDP Deflator = Ʃptqt / Ʃp0qt
The Quantity weights are not fixed in GDP
Deflator.
 2. You get to know the quantities produced
only at the end of the year and so, you get to
know the GDP with a year’s lag.(CPI: a
fortnight lag)
 3. The GDP Deflator considers all goods and
services produced domestically.
GDP

 GDP 2018-19 at current prices (Nominal): Rs189.71

lakh crores
 GDP 2018-19 at constant* prices (Real): Rs139.81
lakh crores
* 2011-12 prices
 Nominal GDP/ Real GDP: GDP deflator = 1.357
 What does it tell us?
– 189.71 = 139.81*(1+i)^7….. therefore i ~ 4.5%
 What would happen to GDP if base year changed?
Inflation

 Inflation(rate) in Year 2 is:

 [(GDP Deflator in year 2 – GDP Deflator in
Year 1) / GDP Deflator in Year 1] * 100
OR
 [(CPI in Year 2 – CPI in Year 1) / CPI in year
1] * 100
Inflation

 What is it now?
 How high & when?
 How low & when?
href='https://www.macrotrends.net/countries/IND/india/inflation-rate-cpi'>India Inflation
Rate 1960-2021</a>
Source: https://www.macrotrends.net/countries/IND/india/inflation-rate-cpi

 Inflation as measured by the consumer price index reflects the

annual percentage change in the cost to the average consumer of
acquiring a basket of goods and services that may be fixed or
changed at specified intervals, such as yearly. The Laspeyres
formula is generally used.
 India inflation rate for 2020 was 6.62%, a 2.9% increase from 2019.
 India inflation rate for 2019 was 3.72%, a 0.22% decline from 2018.
 India inflation rate for 2018 was 3.95%, a 0.62% increase from 2017.
 India inflation rate for 2017 was 3.33%, a 1.62% decline from 2016.