INFLATION – SPECIAL REFERENCE TO INDIA

                                                                            -Dr. S. Vijay Kumar

        Inflation is a measure of the rate of change in prices of selected goods and services over a period of time. It is the rate at which prices of goods and services increase in an economy. It is expressed as a percentage. It is an indication of the rise in the general level of prices over a period of time. Also, it shows the fall in the purchasing power of a rupee.

Measurement of Inflation: As already said, it is the measure of the rate of increase in the prices of goods and services. However, when there  is a decrease in the rate of prices it is called deflation. Since it’s practically impossible to find out the average change in prices of all the goods and services traded in an economy (which would give comprehensive inflation rate) due to the very large number of goods and services present, a sample set or a basket of goods and services is used to get an indicative figure of the change in prices, which we call the inflation rate. Mathematically, inflation or inflation rate is calculated as the percentage rate of change of a certain price index. Generally , two methods are used for calculation of inflation. They are Consumer Price Index (CPI) and Wholesale Price Index (WPI). WPI measures wholesale level price changes. While CPI measures retail level price changes (retail inflation). CPI is one of the most widely used indicators for identifying inflation or deflation in an economy. It is the official barometer of inflation in many countries such as USA, UK, Japan, France, Canada, Singapore, and China). RBI Ex-Governor Raghuram Rajan in April, 2014 changed the policy of calculation of inflation from WPI to CPI (Consumer Price Index), because it is being more rationale (it represents the prices at which consumers buy goods and services) than WPI and it neglects services and the bottlenecks between a wholesaler and a retailer. CPI is more of a common man’s index as it provides numbers on the retail prices of the goods and services consumed by the average Indian, both rural and urban; it is a true indicator of the cost of living.

Inflation rate is typically calculated using the inflation rate formula:

(B – A)/A x 100 where A is the starting number and B is the ending number. The formula requires the starting point (a specific year or month in the past) in the consumer price index for a specific good or service and the current recording for the same good or service in the consumer price index. Subtract to find the difference between the two numbers. This difference indicates how much the consumer price index for the specific good or service has increased. Divide those results by the starting price (the price reported for the date in the past rather than the current date). This will give you a decimal. To convert this number to a percentage multiply by 100. This will give you the rate of inflation. 

Calculation of Inflation in India: A base year is used to compare the measure of rates. For simple understanding, this can be taken   as 'first' year in the time set. Prices in the base year are often taken as 100 to simplify calculations. 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.

In India, there are four consumer price index numbers, which are calculated, and these are as follows:

1.     CPI for Industrial Workers (IW).

2.     CPI for Agricultural Labourers (AL)/ Rural Labourers (RL).

3.     CPI (Rural/ Urban/ Combined).

While the first two are compiled and released by the Labour Bureau in the Ministry of Labour and Employment, the third by the Central Statistics Office (CSO) in the Ministry of Statistics and Programme     Implementation.

4.     CPI for Urban Non-Manual Employees (UNME).

How is Consumer Price Index calculated?

The CPI is calculated with reference to a base year, which is used as a benchmark. The price change pertains to that year. Remember, when we calculate the CPI, note that the price of the basket in 1 year has to be first divided by the price of the market basket of the base year. Then, it is multiplied by 100.

Consumer Price Index formula:

One can measure inflation using CPI or consumer Price Index.

Inflation = ((CPI x+1 – CPIx)/ CPIx))*100

Where, CPIx is Initial Consumer Price of Index

Inflation is calculated using CPI. CPI measures the price change in goods and services by taking a weighted average value of each of them.

CPI = (Cost of Fixed Basket of Goods and Services in Current Year/ Cost of Fixed Basket of Goods and Services in Base Year) *100

Explanation: The percentage change in CPI over a period of time is the inflation over that period for consumer goods. It measures only retail inflation. CPI is determined using a basket of 299 commodities. It calculates the price change of all these 299 goods and services by taking a weighted average value of each of them. Example: Inflation can be better explained with an example. A liter milk used to cost INR 25 in the year 2010. Now the same liter of milk costs INR 50 in 2020. The milk has become dearer (costlier). With the same INR 25, one can get only half a liter of milk in 2020. This is called the falling purchasing power of the currency. Purchasing power of money will fall when the same amount of money is used to buy less of a product as time passes.

Causes of Inflation: Main causes of inflation in India are:

1.     Monetary Policy: It determines the supply of currency in the market. Excess supply of money causes inflation. Hence decreasing the value of the currency. The Reserve Bank of India (RBI) decides the monetary policy in India.

2.     Fiscal Policy: This policy is decided by the Government. It monitors the borrowing and spending of the economy. Higher borrowings (national debt), result in increased taxes and additional currency printing to repay the national debt. This, in turn, increases the money supply in the country.

3.     Demand Pull Inflation: Increase in prices due to the gap between the aggregate demand (higher) and aggregate supply (lower).

4.     Cost Push Inflation: Higher prices of goods and services due to increased cost of production.

5.     Exchange Rates: Exposure to foreign markets are based on the dollar value. Fluctuations in the dollar exchange rate have an impact on the rate of inflation of domestic country.

Types of Inflation:

1.     Demand Pull inflation: It occurs when the aggregate demand for goods or services is higher when compared to the production capacity. The difference between aggregate demand and aggregate supply (shortage) result in price appreciation.

2.     Cost Push Inflation: It occurs when the cost of production increases. Increase in prices of the inputs (labour, raw materials, etc.) increases the price of the product.

3.     Built In inflation: Expectation of future inflation results in Built in Inflation. The rise in the prices results in higher wages to afford the increased cost of living. Therefore, high wages result in increased cost of production, which in turn has an impact on product pricing. The cycle, hence continues.

Effects of Inflation:

The rise in the inflation rate can cause a fall in purchase power.

Inflation could lead to economic growth (increase in GDP growth rates) as it can be a sign of rising demand.

It could further lead to an increase in costs due to workers demand to increase wages to meet inflation. This might increase the unemployment rate as companies will have to lay off workers to keep up with the costs. High unemployment rate further leads to a fall in GDP growth.

Domestic products might become less competitive if inflation within the country is higher. It can weaken the currency of the country. 

Controlling Inflation:

Change the monetary policy by adjusting the interest rates. Higher interest rates decrease the demand in the economy. At the same time, lower rates of interest increase demand. This results in lower economic growth and therefore, lower inflation.

Controlling the money supply can also help in preventing inflation. The money supply is the total value of money in circulation in the country. In India, the Reserve Bank of India controls the money supply.

Higher Income Tax can reduce the spending, and hence resulting in lesser demand and inflationary pressures.

Introducing policies to increase the efficiency and competitiveness of the economy helps in reducing the long term costs.

Consumer Price Index or CPI as it is commonly called is an index measuring retail inflation in the economy by collecting the change in prices of most common goods and services used by consumers. Called market basket, CPI is calculated for a fixed list of items including food, housing, apparel, transportation, electronics, medical care, education, etc. Note that the price data is collected periodically, and thus, the CPI is used to calculate the inflation levels in an economy. This can be further used to compute the cost of living. This also provides insights as to how much a consumer can spend to be on par with the price change.

To conclude, although there were certain difficulties in shifting from WPI to CPI for the measurement of inflation in India, it is in the right direction after a long time.