all you wanted to know about inflation

1. INFLATION
MANUEL M.MATHEW
CIVIL SERVICE INSTITUTE PALA
LOURDES CAMPUSTRIVANDRUM

2. •Inflation is a state of persistent rise in prices
•Note:
this does not mean that all prices must be rising
during a period of inflation –some prices may
even be falling; but the general trend must be
upward
It is a process of rising prices & not a state of
high prices

3. Price Index
•A price index is a normalized average (typically a
weighted average) of price relatives for a given class of
goods or services in a given region, during a given
interval of time. It is a statistic designed to help to
compare how these price relatives, taken as a whole,
differ between time periods or geographical locations.

4. Measuring Inflation
•Inflation is the rate of change in the price index
•If the price level in the current year is ‘P1’ & in the
previous year is ‘Po’, then inflation for the current
year is
(P1 – Po)/ Po x 100

5. Why inflation is bad?
Inflation causes welfare loss for the people
inflation destabilizes of economic activities like
savings, investment , employment, economic
growth, etc.

6. Types of Inflation
•Classification of inflation in terms of
intensity
Creeping inflation (around 2%),
Walking inflation (around 8 – 10%),
Galloping inflation (40 –60% monthly),
Hyperinflation (> 60% monthly)

7. •Open Inflation and Suppressed inflation
Open inflation – inflation not blocked by
counter measures – i.e. no barrier to price
rises.
Suppressed inflation- inflation suppressed
by restrictive monitory and fiscal policies.

8. •Anticipated inflation and unanticipated
inflation.
Anticipated inflation is inflation which is
anticipated by economic agents. They
arrange their responses in accordance with
anticipated inflation.
 Unanticipated inflation: this unexpected
inflation for various economic agents

9. Other classifications of inflation
•Structural inflation
Structural inflation is the one prevailing in most
developing countries. The situation is due to the
operation of the structural weakness (supply
bottleneck, lack of infrastructure, etc.) existing in a
developing economy. Lack of adequate supply
responses or production to increase in demand is
the cause of structural inflation.

10. •Stagflation
Stagflation is a hybrid of inflation and stagnation.
Stagnation is very low economic growth. Usually
inflation is accompanied growth of the economy.
In this sense, stagflation is a paradoxical situation.
Since both inflation and stagnation are
undesirable economic conditions, stagflation is
double pain for the economy.

11. •Skewflation
Skewflation means the skewness of inflation
among different sectors of the economy —
some sectors are facing huge inflation, some
none and some deflation.

12. Classification in terms of origin
Cost -Push inflation
Cost-push inflation occurs when firms respond to
rising costs by increasing prices in order to protect their
profit margins. There are many reasons why costs might
rise:
• Component costs
• Rising labour costs
• Expectations of inflation
• Higher indirect taxes
• A fall in the exchange rate
• Monopoly employers/profit-push inflation

14. •Wage-Price Spiral
•WhenW ↑ → P ↑ → cost of living of the workers ↑
•Again whenW ↑ → P ↑ → real wage rate ↓
Both the consequences lead the trade unions to claim a
higher money wage
If this claim is granted by employers, there is a second
round price inflation caused by the cost factor
Thus, there is a wage-price spiral
W ↑ → P ↑ → W ↑ → P ↑

15. •Demand- pull inflation-
Demand pull inflation is caused by increased
demand from the consumers. It is often described
as increase in demand without adequate increase
in supply of output. In other words demand pull
inflation occurs when aggregate demand is
growing at an unsustainable rate leading to
increased pressure on scarce resources.

16. Main causes of Demand-Pull Inflation
• Increased Money supply
• A depreciation of the exchange rate
• Higher demand from a fiscal stimulus
• Fast growth in other countries

18. Other types of price level movements
• Disinflation
Disinflation is the slowing rate of inflation. Disinflation
condition indicates that the inflation rate is coming
down marginally over a short term. Disinflation is
different from deflation. Deflation is decline in prices,
whereas disinflation is decline in inflation rate.

19. •Reflation
Reflation is stimulating the economy by producing
inflation. It is done by increasing money supply or by
reducing taxes. The reflationary exercise is often made
by the government and the central bank is done to bring
back the economy from recession. In effect, reflation is
the opposite of disinflation.

20. •Deflation
Deflation is the opposite condition of inflation. It is general
decline in prices; often caused by a reduction in the supply of
money or credit. Deflation can be caused also by a decrease in
expenditure by government, consumers or business people.
Deflation produces many side effects. The major one is that it is
a disincentive for the producers. Because of the declined
demand and lower investment, unemployment occurs in the
economy. Gradually, deflation can worsen into a recession and
depression. It is often said that among the two undesirables-
inflation and deflation; deflation is more dangerous. Hence,
Central banks try to avoid severe deflation.

21. Price spiraling effect of inflation
Inflation has a tendency to pass on from one sector to
the other depending upon the prevailing conditions. In
developing countries like India, inflation often begins in
primary commodities like food and fuel. Price rise may
be appearing in one sector or in few commodities. But it
always has the tendency to spread all over the economy-
into different goods and services. Some essential
commodities with wide use have the capacity to
generate price rise in other areas. Price rise in basic
goods spreading to other commodities is called price
spiraling effect.

22. Effects of inflation:
• Effects on Distribution: Fixed income recipients lose (wage
earners, salaried class, interest earnings from bank deposit,
debentures, bond etc). Inflation is disincentive to the saving
class. (Inflation is a tax on the saving class) Flexible income
earners gain (Producers, traders, speculators etc.) Holders of
money will lose.
• Effect on creditors and debtors: Debtors gain, creditors will
lose. Governmental will gain, since it is a big debtor.
• Effects on Production: inflation discourages saving
encourages hoarding and speculative activities and hence
discourages productive activities.

23. Philip’s curve: the unemployment inflation trade-off
•Philip’s curve shows a trade-off between inflation and
unemployment. Unemployment can be reduced by
accepting inflation. The concept has been developed
out of a study made by British Economist William
Philips on the British economy. The Phillips curve brings
an inverse relationship between the rate of
unemployment and the rate of inflation in an economy.

25. •The logic of Philip’s curve is the so called money
illusion. During inflation, the real wage of the people
declines, given the money wage. If the employers
increases wage rate slightly, to accommodate
inflation, the laborers may think that their wage has
increased and hence many unemployed people will
offer work. Thus unemployment decreases as a result
of inflation adjustment.

26. Long run Phillips Curve

27. Measures to contain inflation
•Monetary Policy Measures
Credit control
Demonetisation
Issue of new currency

28. •Fiscal Policy Measures
 Reduction in unnecessary expenditure
 Increase in direct taxes
 Decrease in indirectTaxes
• Trade measures
Reducing import duties
Export control

29. •Administrative measures
Enhanced supply of food grains and through the public
distribution system (PDS).
Maintaining Buffer stock.
 Minimum Support Prices (MSPs)
Launch of specific programmes for greater production
of specific items.
Wage and price control.
Rationing of goods.

30. MEASUREMENT OF
INFLATION IN INDIA

31. Different price indices in India

32. TheWholesale Price Index (WPI)
•The wholesale price index is an index that
measures and tracks the changes in the price of
goods in the stages before the retail level. WPI
shows the average price change of goods included
in the index and is often expressed as a ratio or
percentage, and the change is one indicator of a
country's level of inflation.

33. TheWholesale Price Index (WPI)
•Measure of average change in wholesale price .
• Published by the Office of Economic Adviser, Ministry of
Commerce and Industry.
•nationwide inflation indicator till the emergence of the
combined CPI in 2011.
• prices are collected from wholesalers.
• TheWPI is released on a monthly basis.
•Present base year is 2011-12
•Number of commodities in the basket also increased to 697.

34. WPI- Weights, Number of Items & Number of Quotations
Base Year- 2011-12

35. New WPI-Features
Updated item basket and weighting structure conforming to the
structure of economy in 2011-12.
 Increase in number of items from 676 to 697. In all 199 new
items have been added and 146 old items have been dropped.
 The new series is more representative with increase in number of
quotations from 5482 to 8331, an increase by 2849 quotations
(52%) .

36.  Prices used for compilation do not include indirect taxes in
order to remove impact of fiscal policy.
It will make the newWPI conceptually closer to ‘Producer
Price Index’.
A new “WPI Food Index” will be compiled to capture the
rate of inflation in food items.
Seasonality of fruits and vegetables has been updated to
account for more months as these are now available for
longer duration

37. Consumer Price Index
A Consumer Price Index (CPI) is designed to measure the
changes over time in general level of retail prices of selected
goods and services that households purchase for the purpose
of consumption. Such changes affect the real purchasing
power of consumers’ income and their welfare.The CPI
measures price changes by comparing, through time, the cost
of a fixed basket of commodities.The basket is based on the
expenditures of a target population in a certain reference
period.

38. Two Ministries engaged in CPI construction:
 Ministry of Statistics and Programme Implementation
(MOSPI)
 Ministry of Labour and Employment (MOLE)

39. CPI by MOSPI (CSO)
The CSO, which comes under MOSPI
 CPI-rural
CPI- urban
CPI- combined .
 Published from 2011 onwards.
 CPI combined is the most important of all the CPIs.
• In April 2014, the RBI has selected the all India CPI (of CSO) as
the inflation index to target inflation under its new inflation
targeting monetary policy framework. RBI’s decision has made
the CPI as the prime inflation index.

40. • The base year has been revised from 2010 to 2012
• the revised series is released w.e.f.January, 2015
• The basket of items and their weighing diagrams have been prepared
using the Modified Mixed Reference Period (MMRP) data of
Consumer Expenditure Survey (CES), 2011-12, which is 68th Round of
National Sample Survey (NSS).
Notes
MMRP - Data on expenditure incurred are collected for the items falling under
edible oil, egg, fish and meat, vegetables, fruits, spices, beverages and processed
foods, pan, tobacco and intoxicants during last seven days; clothing, bedding,
footwear, education, medical (institutional), durable goods during last 365days;
all other food, fuel and light, miscellaneous goods and services including non-
institutional medical; rents and taxes during last 30 days.

41. CPI- Rural, Urban and Combined

42. All India Sub-group/GroupWeights

43. CPIs by MOLE (Labour Bureau)
•The Labour Bureau, Ministry of Labour and Employment
(MOLE) is preparing different indices for various
categories of people.
 CPI for Rural Labourers (CPI-RL),
 CPI for Agricultural Labourers (CPI-AL)
 CPI for IndustrialWorkers (CPI-IW).
•Since these CPIs were for specific categories of workers,
it lacked the quality of an all India index.

44. CPI-RL/AL

46. CPI for IndustrialWorkers (CPI-IW)

49. What is the difference between the various CPIs?
•Difference between the various CPIs is not just
that they measure price level changes for different
sectors or groups. In addition to such a sector
specific price level measurement; these indices
differ in terms of their geographical coverage,
commodities included, weights assigned to the
different commodity groups and the base year on
the basis of which price level changes are
compared.

50. • Headline Inflation: Measure of the total inflation within an
economy, including commodities such as food and energy prices
(e.g., oil and gas), which tend to be much more volatile and prone
to inflationary spikes. What the CPI and WPI figures shows to us is
the headline inflation. When we remove the transitory or seasonal
inflation from headline inflation, we get core inflation.
• Core Inflation: Measures change in prices of goods and services,
but does not include those from the food and energy sectors. CPI
Core is CPI combined – Food and Fuel Component. In other words
Core inflation which is also called underlying inflation, excludes
seasonal inflationary factors such as food and energy costs.
• Refined Core Inflation : CPI Combined – (Food and Fuel, Petrol
and Diesel components)

51. •Central banks including the RBI are very keen on sorting
inflation into core and headline inflation from the
perspective of monetary policy implementation. The
logic of such a demarcation is due to the fact that the
RBI need not or can’t influence price rise when such price
rises are temporary that occurs in the case of primary
commodities like food.

52. Why there is the need for making a difference?
•For example, in the case of food inflation, it may have
appeared instantly, due to sudden shortages. This price
rise may disappear soon. If the RBI makes a monetary
policy intervention for such seasonal or temporary
inflation, the price rise may disappear by the time when
the RBI’s policy becomes effective. Here, the monetary
policy intervention becomes ineffective.

53. Consumer Food Price Index(CFPI)
• Consumer Food Price Index (CFPI) is a measure of change in retail
prices of food products consumed by a defined population group
in a given area with reference to a base year. CFPI is based on
retail price quotations .
• The Central Statistics Office (CSO)
• for three categories -rural, urban and combined - separately on
an all India basis with effect from May, 2014.
• calculated on a monthly
• methodology remains the same as CPI.
• The base year presently used is 2012.

55. WPI Food Index
• A new WPI Food index compiled on a monthly basis to
estimate theWPI based inflation in food items
• This index is estimated by taking the aggregate of WPI for
Food Products (9.12) under Primary Articles and Food Articles
(15.26) under Manufactured Products.
• The total weight ofWPI Food Index will be 24.38
• Effective monitoring of food inflation at wholesale level