1. Inflation Measures, Money
Demand and Production Linkages
Dr Archana Pillai
IMT Hyderabad

2. Inflation
 Outside a shop where Christmas trees are being
sold…
“Is it going to be the same size as last year or the same
price as last year?”
 Sustained increase in the general price level
 General Price Level – measured as consumer prices
and wholesale prices/industrial goods prices
 More about value of money than about value of
goods

3. Related concepts
 Velocity of money
 (P *Q)/M = V
 MV = PY (Fisher Equation)
 Money Neutrality
 Assumes no role of money in the effect on real output
 Short run changes do happen
 Assumes no effect on production, wages and interest rates
 Weak concept

4. Types of inflation
 Creeping
 Crawling
 Galloping
 Hyperinflation
 Stagflation
 Cost push
 Demand pull
 Headline vs Core (WPI – food and fuel)

5. Cost push Inflation
 Comes through increases in factor prices
 Wages
 Raw materials
 Affects the Aggregate supply
 Affects productivity


Wage push inflation
Profit push inflation


By oligopolists or monopolists – greed to get more
Wage price spiral

6. Demand pull Inflation
 Comes through increased goods demand
 Change in the Aggregate Demand function
 Changes in interest rates can affect demand
 Govt expenditure shifts AD
 Excessive foreign inflows affect AD

Inflationary gap


The amount by which AD exceeds aggregate output at full
employment level
Causes inflationary spiral

7. Effects of Inflation
 Income distribution
 Producers – profit earners gain
 Wage Earners
 Depends on bargaining power
 Retired/Aged
 Suffer from low value of savings
 Investors
 Equity – gain; Interest earners – lose
 Debtors/Creditors
 Debtors – gain; creditors - lose

8. Effects…
 Rent earners
 Fixed contracts – hurt
 Effect on Wealth distribution
 Effect on Output and Employment
 Leads to improvement in resource allocation
 Negative in terms of productivity losses

9. Deflation
 Persistent and appreciable fall in prices
 Where AD falls short of available output
 Pessimism
 Leads to idle capacity in various sectors
 Reverse multiplier gets into action
 MEC falls
 Inflation vs Deflation – former preferred (Why??)

10. Stagflation
 Unemployment, lack of growth and inflation
 Rise in prices – causes fall in output
 Expectations of future prices – also downward
 No incentive to borrow – since costs are high
 No incentive to produce – since demand is low
 No incentive to consume – since prices are high
 Kind of very low economic equilibrium –
experienced by developed economies – US and
Germany

11. Other costs..
 Shoeleather Costs
 Resources wasted when inflation encourages people to reduce
their money holdings and keep more money in banks (interest
bearing assets)
 Menu costs
 Costs of changing prices
 Printing, informing – customer annoyance costs

12. Consumer Price Index
 CPI – IW


The CPI-IW purports to measure the temporal change in the retail
prices of fixed basket of goods and services being consumed by the
target group i.e. an average working class family and thus, is an
important indicator of the retail price situation in the country.
Used for determination of DA
 CPI – AL/RW – to be done away with
 CPI – Urban
 CPI – Rural
 CPI - combined
 Base year 2013-14 = 100 (New)
 http://labourbureau.nic.in/indexes.htm

13. CPI - Weights
 Food, Beverages and tobacco (49.71)
 Fuel and light (9.49)
 Clothing, bedding and footwear (4.73)
 Housing (9.77)
 Misc (26.31)
 Conduct of Income and Expenditure Survey (NSSO)
 Organisation of price collection work
 House Rent surveys – rented and self-owned

14. CPI..
 Base year fixation
 Method – Base year price * Base year quantity;




Current year price* Base year quantity
New base year 2010 – released in Feb 2011
310 towns – 1114 price schedules – on average 250
items per month
CPI (Rural) – 1181 villages
Price collectors – Post officials

15. Wholesale Price Index (2004-05)
 Rationale to Compute WPI
 Concept of wholesale price


Agricultural commodities
Non – agricultural (ex-factory gate price)
 Wholesale price vs producer price – latter includes taxes
and transport charges
 Selection of items (total number of items – 676 in basket)


Agricultural items (M/O Agriculture), National Horticulture
Board, Spices Board, Tea board, Coffee Board and Rubber
Board, Silk Board, Directorate Of Tobacco, Cotton Corporation of
India )
Organized manufacturing

16. WPI…
 ASI Prices
 Unorganized/unregistered
manufacturing - Own
Account Enterprise (OAE), Directory Manufacturing
Establishment
(DME)
and
Non-Directory
Manufacturing Establishment (NDME), Economic
Census and its follow up surveys and Census of
Registered SSI units

17. WPI groups
 Primary Articles
 Fuel, Power, Light and Lubricants
 Manufactured Products
 Weightages – 20.11, 14.91 and 64.97
 Refer doc WPI weights - observations

18. WPI vs CPI
 Why different measures
 Importance of both
 Measurement in India
 Need for a consolidated index
 CPI (Rural + Urban)

19. Index of Industrial Production
 Index of Industrial Production (IIP) is an abstract





number, the magnitude of which represents the
status of production in the industrial sector for a
given period of time
Basic goods
Capital goods
Intermediate goods
Consumer durables
Consumer non-durables

20. IIP..
 543 items
 Method of data collection – ASI data
 WPI deflators – 2004-05 used
 Index of 6 core industries
 26.7% weight – growth of 6.8% over previous year
 Crude Oil, Petroleum Refinery Products, Coal, Electricity and
Cement and Finished Steel
 Relevance of measure
 Usefulness
 Drawbacks

21. Relevant websites
 www.labourbureau.gov.in
 www.data.gov.in
 www.indiabudget.nic.in
 www.eaindustry.nic.in
 www.rbi.org.in
 For class tomorrow – readings on the RBI website –
money supply