inflation

                   INFLATION

Inflation is the situation characterized by a sustained unchecked rise in the general price level & a fall in the purchasing power of the money observed over a period of time.

Related terms

1.      Creeping Inflation is the rate of general price increase of 1-5% per year. Creeping inflation of 3-5% erode the purchasing power of money when continued over many years but it is manageable. Furthermore a low creeping inflation could be good for the economy as producers & traders make reasonable profits encouraging them to invest.

2.      Rotating Inflation is usually defined as a 5-10% annual rate of increase in the general level of prices that if not controlled might accelerate into a galloping inflation of 200-300% a year. If it aggravates galloping inflation can worsen to runs away inflation which may change into hyper inflation.

3.      Hyper Inflation: It is which is out of control. A condition in which prices increase rapidly as currency loses its value. People loose faith in the currency of the country and govt. may think in terms of using alternate currency or switch over to Barter system: Zimbabwe (2010), Argentina (1999) Germany (1920-21).

4.      Deflation: When there is a general fall in the level of prices.

5.      Disinflation: It is the reduction of rate of inflation.

6.      Stag Inflation: A situation in which inflation co-exist with recession, slow down & unemployment.

Measurement of Inflation (3 methods)

1.      Wholesale Price Index (WPI)

2.      Consumer Price Index (CPI)

3.      GDP Deflator

Inflation is measured in India on the basis of WPI & CPI. WPI is used to measure the rate of inflation, which is called headline rate of inflation. This is the rate projected in newspaper periodically. WPI is constructed on the basis of 676 commodities with base year 2004-05. It does not include services. This index is based on wholesale prices which are collected from major wholesale markets in India.

This index givens predominant weightage of 65% to manufactured goods & just 20% to food & primary articles. WPI is calculated on Laspeyers formula i.e. weightage arithmetic mean based on the fixed value, base, weights for the base period. Here items are classified into 3 categories:

1.      Primary articles (vegetables, fruits etc.) (Weight 20.12%)

2.      Fuel, Power, Light, Lubricants (Weight 14.91%)

3.      Manufactured Products( Weight 64.97%)

Whenever inflation is more pronounced in food & primary articles it is not adequately reflected in WPI like the kind of inflation. India is witnessing in previous years. Besides the fact that this index is based on wholesale prices mean that it is not representative because masses buy goods at retail prices. No country uses WPI & most countries use CPI. This is called Headline Inflation because this includes the entire set of commodities in general price index.

While core inflation does not take into consideration commodities that have volatile prices e.g. food & fuel. This is compiled by economic advisor under ministry of commerce.

Limitations of WPI

The accuracy of WPI is unsatisfactory even after the introduction of the revise series 2010 services such as rail, road transport, health care, banking & insurance are not part of WPI basket. Neither are the products of unorganized sector that are estimated to constitute about 35% of the total manufactured output of the country. The index thus fell short of being a broad based indicator of the price level even in its construction.

Consumer Price Index

In 2011, the CPI system was reformed. Before 2011 there were 4 such types of CPI.

1.      CPI – Agricultural labourers

2.      CPI – Rural Population

3.      CPI – Urban & Rural Population

CPI is compiled by central statistical organization on under ministry of statistics (CSO). CPI has base year 2011-12 & even includes services.

GDP DEFLATOR

It is calculated by CSO under the ministry of statistics. GDP stands for gross domestic product i.e. the total value of all the final goods & services produced within the economy during the specified period. GDP deflator is the measure of the changes in price of all new domestically produced final goods & services in an economy. The GDP deflation is not based on a fixed market basket of goods & services but applies to all goods & services domestically produced.

GDP deflator = GDP at current price

                        GDP at constant price

GDP deflator is the most comprehensive no. to measure inflation. But RBI & govt. does not use it much for policy making because GDP deflator data comes quarterly not weekly or monthly.

Point to Point Deflation

Inflation during a week ending in the current year as compared to the corresponding week ending last year, thus the point to point inflation. Early WPI was calculated on weekly basis that point to point basis. Now it is calculated on monthly basis.

Producer Price Index (PPI)

It is the index constituted to measure inflation on the basis of price prevailing at the producer level. This index does not include transportation cost, trader profits margins & indirect taxes. The objective of constructing the index is to address price rise if any. At the producer level before it passes on the consumer a large number of advanced countries have started using PPI.

Service price index

1 Railway Service Price Index 

2   Postal Service Price Index

3   Banking Service Price Index 

 4 Telecom (Cellular) Service   Price Index

5 Air Service  Price  Index

History of WPI

Government launched a new series of WPI with 2004-05 as base from 2010. Earlier 1993-94 was used a base year to calculate WPI. The new series of WPI has 676 items as against 435 items in previous series. Consumer items widely used by middle class like ice cream, mineral water, flowers microwave oven, gold, silver & washing machine are reflected in the new series of WPI. This would give better picture of price variation. Readymade food, computer, stationery, dish, petroleum products are also part of new series. Under primary article group of new WPI there are 102 items against earlier 98. While fuel & power category remains static at 19. In the new series there are 555 items of manufacturing products compared to 318 items earlier. 241 new items are there in the basket of commodities making up the official WPI in a bid to reflect changes in India price line & consumption pattern. The new series is based on the recommendation of a working group that was set up under planning commission member Abhijeet Singh recommended the change of base year to 2004-05. Manufactured items have a higher weight of 64.972 as against 63.749 as earlier. The weight for fields has also increased articles the weight is down at 20.118 against 22.025. In a bad to reflect the actual consumption pattern the new series drops as many as 200 items such as typewriter, video cassette to make a room for items like computer, refrigerator, T.V. & video disk player. The WPI published weekly by the economic advisor in ministry of commerce & industry with a two week lag, tracks the wholesale traded prices of 676 items that include agricultural commodities such as rice, tea, cotton etc., industrial commodities such as iron, bauxite etc., intermediate products for consumer like atta, sugar, paper, electricity, ceiling fan etc. & energy items like petrol, kerosene, eldritch for commercial use (power). The weight attached to each item in the index is mean to reflect the volume by value of wholesale trade the volume by value of wholesale trade in that item in the Indian market. The wholesale price index is an indicator designed to measure changes in price levels of commodities that flow into the wholesale trade. The WPI is the only price index in India which is available on a weekly basis with a shortest possible time lag of 2 weeks. It has an all India character. It is due to these attributes that it is widely used in business & industry circles & in the govt. & is generally taken as an indicator of rate of inflation in the economy.

WPI new reporting method

From 2009 govt. presented WPI inflation figures on a monthly basis instead of week system. Analyst say since weekly data on WPI based inflation do not adequately capture the movement of prices of manufactured goods. Govt. has to often service the figures later on therefore govt. decided to have weekly release of inflation data on food & fuel prices & monthly data on WPI but from 2011 WPI is reported every month including food & fuel.

CPI History

There are 3 consumer price indices in India. Each tracks the retail prices of goods & services for specific group of people because the consumption patterns of different groups differ. For industrial worker CPI a basket of 370 commodities is tracked. For CPI urban non manual employees 180 commodities, for agricultural labourers 60 commodities. The respective base year are 2001, 1984-85 & 1986-87. CSO decided to discontinue CPI for urban non manual employees from 2008. In accordance with govt. of India business rule 1961 it is the responsibility of ministry of labour to compile & release the data on CPI for industrial workers & the responsibility of ministry of statistics & programme implementation to compile & release the data on CPI for urban non-manual employees. Mahatma Gandhi NAREGA wages are to be fixed to CPI agricultural labourers for the beginning of year 2011.

New CPI Series

The central statistic office of ministry of statistic & programme implementation introduced the new series of CPI for rural, urban & combined (rural + urban) on base 2010 taking all segments of rural & urban population for the States/UTs & all India. Since 2011 February, the new series is enforced. These indices are available for 5 major groups namely food, beverages & tobacco, fuel & light, housing, clothing, bedding & footwear & miscellaneous.

The present CPI numbers i.e. CPI-AL, CPI-IW do not encompass all the segments of population in the country & they do not reflect the true picture of price behavior in the country. It is therefore necessary to compile a CPI which takes into account the consumption patterns of all segments of population & includes services.

Inflation is based on following causes:

1.      Demand Pull Inflation: Inflation caused by increase in demand due to increased private & govt. spending. Demand pull inflation can be caused by increasing in money supply.

2.      Cost Push Inflation: It is also referred to as supply inflation caused by reduced supply due to increased prices of inputs e.g. crude prices globally have gone up causing supply constraints which means higher cost of production & so higher prices. Food prices are shooting up due to deficient monsoon & global shortages.

3.      Structural Inflation: A type of persistent inflation caused by deficiency in certain conditions in the economy such as a backward agriculture sector i.e. is unable to respond to people increased demand for food, inefficient in distribution & storage facilities leading to artificial shortage of goods & production of some goods controlled by some people.

4.      Speculation

5.      Cartelization

6.      Hoarding

Problem of High Inflation

1.      Low income groups are particularly hurt.

2.      People on a fixed income i.e. pensioners, students will be worse off in real terms due to higher prices & equal income as before.

3.      Inflation discourages exports as domestic sales are attractive & balance of payment problem can be caused. Inflation may erode the external competitiveness of domestic products if it leads to higher production cost such as wage increase, higher interest rate & currency depreciation.

4.      Inflation can drag down growth as investment climate turns bad due to instability & uncertainty & also as interest rates are raised & cost of credit increases.

5.      Inflation may discourage savings & thus hit investment.

6.      Inflation tax happens.

7.      It will redistribute income from those on fixed incomes such pensioners & shift it those who draw an inflation linked business & incomes.

8.      Strikes can take place for higher wages which can cause a wage spiral.

Benefits of Inflation

1.      Small amount of inflation can be good. Inflation means growth, normally higher incomes & more demand & so more inflation.

2.      It can be argued that a low level of inflation can be good if it is a result of innovation.

3.      New products are launched at higher prices which quickly come down through competition therefore there is encouragement for innovation & the problem is short lived, also a small price rise is necessary for wages to go up.

  Composition of indicators

Title	CPI-IW	CPI-AL	CPI-RL	WPI	CPI*
Base	2001	1986-87	1986-87	2004-05	2012
lag **	1 month	18 days	18 days	14 days	18 days
Elementary  items	320	260	260	676	200 weighted items #
Weight of food Products	48.47	69.15	66.77	24.3	45.86
Weight of enrgy (%)	7.43	8.35	7.9	14.91	6.84
Weight of misc. items, which primarily include services (%)	23.26	11.73	11.87	Services not included	28.32
No. of collection centers	78 urban	600 rural	600 rural	Centralised collection	1181 villages and 310 towns

Consumer price index  (base year revised from 2010 to 2012)

groups	Revised series of cpi base 2012 Rural                urban                combined
Food and beverages	54.18	36.29	45.86
Pan , tobacco and  intoxicants	3.26	1.36	2.38
Clothing and footwear	7.36	5.57	6.53
housing	-	21.67	10.07
Fuel and light	7.94	5.58	6.84
miscellaneous	27.26	29.53	28.32
items	225	250	475

INFLATION current status

The annual rate of inflation, based on monthly WPI, stood at -4.95% (provisional) for the month of August, 2015 (over

August, 2014) as compared to -4.05% (provisional) for the previous month and 3.85% during the corresponding month of the previous year. Build up inflation rate in the financial year so far was 0.34% compared to a build up rate of 3.11% in the corresponding period of the previous year.

The   Phillips curve

The Phillips curve shows the relationship between unemployment and inflation in an economy. Since its ‘discovery’ by British economist AW Phillips, it has become an essential tool to analyse macro-economic policy.

stated simply, decreased unemployment, (i.e., increased levels of employment) in an economy will correlate with higher rates of inflation.

While there is a short run tradeoff between unemployment and inflation, it has not been observed in the long run

Inflation  targeting

The Reserve Bank of India has announced that it is adopting inflation targeting as its guide to monetary policy. There’s been a general  move by central banks to this policy over recent years and there’s good reason for it too. So that’s one point, that the RBI is following in line with generally accepted best practice on monetary policy.

The  Reserve Bank of India (RBI), the country’s central bank, made public an agreement with the Ministry of Finance that mandates the RBI to bring inflation below 6% by January 2016, and 4% (plus or minus 2%) in the following years.