- Inflation refers to the rise in general price level in the country over a period of time. Inflation could be monetary or price inflation.
- When you have inflation more money is being circulated in the economy which causes the currency to lose its purchasing power and this leads to an increase in the price of goods and services. Over the course of many years, economic cycles go through periods of inflation, deflation and
- Each one of these has a specific effect on the overall economy as a whole and sometimes can lead to long periods of recessions or depressions in the
5.1 CAUSES OF INFLATION
- Inflation is caused due to a mismatch between demand and supply, i.e., when demand exceeds supply. Thus, inflation can occur due to changes in the demand side or the supply side or
5.1.1 Demand Side Inflation
- It is also known as ‘Demand Pull’
- Increase in demand can occur due to many reasons, such as
- Increase in public expenditure, especially by the government operating large fiscal
- Loose monetary policy of the Central Bank, which leads to low interest rates and thus, higher
- Rapid GDP growth, which leads to more employment, higher wages.
- Increase in
- Depreciation of exchange rate, which reduces imports, increases exports and thus, pulls up
- Reduction in direct taxes, which puts more money in the hands of
- Speculation in commodities market
5.1.2 Supply Side Inflation
- It is also known as ‘Cost Push’
- Factors influencing inflation from the supply side can also be many, such as
- Backward agricultural sector, which is not able to produce enough food.
- Inefficient storage, transportation and marketing infrastructure, which leads to wastage and reduction in
- Hoarding by traders of essential items, artificially reduces supply and causes
- Rise in the prices of crude oil, fertilizers
- Rise in labour
- Higher costs of imported materials.
- Higher cost of capital due to squeezing of credit by the Central Bank.
- Cartelisation by a few big suppliers to fix prices arbitrarily to make undue
- Monopoly of a single supplier in the market, enabling him to set arbitrary
- Pushing up of profits by the management of a company by increasing the prices also leads to inflation.
- It has to be understood that it is not always easy to differentiate between demand and supply side inflation and an example from the demand side can also be explained from the supply side and vice- versa.
5.2 EFFECTS OF INFLATION
- Inflation affects different people differently. When price rises or the value of money falls, some groups of the society gain, some lose and some stand in
- Let us discuss the effects of inflation on distribution of income and wealth, production and on the society as a
5.2.1 On Business Community
- Inflation is welcomed by entrepreneurs and businessmen because they stand to profit by rising
- They find that the value of their inventories and stock of goods is rising in money terms. They also find that prices are rising faster than the costs of production, so that their profit is greatly enhanced.
5.2.2 On Fixed Income Groups
- Inflation hits wage-earners and salaried people very hard. Although wage-earners, by the grace of trade unions, can chase galloping prices, they seldom win the
- Since, wages do not rise at the same rate and at the same time as the general price level, the cost of living index rises and the real income of the wage earner decreases.
5.2.3 On Farmers
- Farmers usually gain during inflation, because they can get better prices for their harvest during
5.2.4 On Investors
- Those, who invest in debentures and fixed-interest bearing securities, bonds etc lose during inflation. However, investors in equities benefit because more dividend is yielded on account of high profit made by joint-stock companies during
- Inflation will lead to deterioration of gross domestic savings and less
capital formation in the economy and less long-term economic growth rate of the economy.
5.3 OTHER INFLATION RELATED CONCEPTS
- 3.1 Deflation: A general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be also caused by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.
- 3.2 Stagflation: When you have a slow economy with high inflation rates and unemployment, stagflation is usually the result. When the economy does not grow and prices continue to rise you have a stagflation cycle in the economy.
- 3.3 Disinflation: This is a reduction in the rate of inflation over time, even though inflation itself may be positive.
- 3.4 Reflation: It is an attempt to bring back inflation in an economy, which is in deflation so as to induce growth.
5.4 MEASURES OF INFLATION
- Inflation refers to the changes in general price level in the country over a period of
- There are three standard measures of inflation, viz
- Wholesale Price Index (WPI)
- Consumer Price Index (CPI)
- In India, to measure the price level, the Wholesale Price Index and the Consumer Price Index are
5.4.1 Wholesale Price Index (WPI)
- It measures the change in wholesale prices on weekly basis. But since 2009 it has been made monthly. Average annual wholesale prices of the current year are related to average annual wholesale prices of the base year (assumed as 100). This index covers 676 commodities and does not account for the
- Weights are accorded to different goods depending on their relative significance. In preparing the Wholesale Price Index, higher weightage is accorded to the manufacturing products than the others.
- Precisely, 65% weightage is accorded to manufactured products, 1% to primary articles and 14.9% to fuel and lubricants.
5.4.2 Consumer Price Index (CPI)
- It measures the change in retail prices on monthly basis. On the basis of monthly indices, average annual CPI is worked out. Average annual retail prices for the current year are related to the average annual retail prices of the base year (assumed as 100). Like wholesale price index, different goods are accorded weights depending on their relative significance.
- It needs to be emphasized that while WPI includes goods only, CPI includes both goods as well as services. Another important feature of CPI is that it focuses on
a homogeneous group of consumers.
- CPI reflects cost of living of the concerned category of consumers. CPI for the industrial workers is a widely used index in India. It is also used to determine the dearness allowances of government
- Besides, CPI of agricultural labourers, CPI for urban non- manual employees are also calculated by the economists for some specific
5.4.3 New Consumer Price Indices
- At the retail level, CPI is meant to reflect the cost of living conditions and is computed on the basis of the changes in the level of retail prices of selected goods and services, on which consumers spend the major part of their income.
- Therefore, a broad-based CPI for the country as a whole, including both services and manufacturing products, has greater relevance for Monetary Policy
- In India, however, data on CPI relates to different segments of the population rather than the entire population. With a view to addressing this issue, the Reserve Bank has taken the initiative and prepared an approach paper on CPI (Urban) and CPI (Rural).
- Subsequently, the Central Statistical Organisation (CSO) has taken up the work for generating data on CPI (Urban) and CPI (Rural). The new CPIs once complied will go a long way in filling a major data gap in price statistics.
5.4.4 Introduction of CPI (Urban) and CPI (Rural)
- The Central Statistical Organisation (CSO) has taken up a new initiative of compilation of CPI (Urban) CPI (Rural) and CPI (rural+urban) for all States/UTs and all India by considering all sections of the urban and rural population.
- In urban areas, all cities/towns having population (2001 Population Census) more than 9 lakh and all State/UT capitals not
covered therein were selected purposively. In all 310 towns have been selected either on purposive or random basis, from which 1114 quotations (price schedules) are canvassed every month.
- In rural areas, with a view to having a manageable workload and considering that the CPI (Rural) would provide the price changes for the entire rural population of the country, a total of 1183 villages have been selected at all India
- The CSO has also decided to bring out a national CPI by merging CPI (Urban) and CPI (rural) with appropriate weights, as derived from NSSO 61st round of Consumer Expenditure Survey (2004-05)
5.4.5 Producer Price Index
- Even, when we have a revised WPI, we would still not have a Producer Price Index (PPI). The PPI covers price changes faced by the producers on primary, intermediate and finished goods and services ready for the
- The primary difference between the WPI and the PPI is, in addition to the coverage, that the WPI reflects changes in the average cost of production including mark-ups and taxes, while the PPI measures price changes of transacted goods at the gate excluding
- The purpose of the PPI is to provide a measure of prices received by producers of commodities. The PPI usually covers the industrial (manufacturing) sector as well as public utilities (electricity, gas and communications). Some countries also include agriculture, mining, transportation and business services.
5.4.6 GDP Deflator
- It refers to the ratio between GDP at current prices and GDP at constant prices. If GDP at Current Prices = GDP at Constant Prices, GDP deflator = 1, implying no change in price level. If GDP deflator is found to be 2, it implies rise in price level by a factor of 2 and if GDP
deflator is found to be 4, it implies a rise in price level by a factor of 4.
- GDP deflator is acclaimed as a better measure of price behaviour because it covers all goods and services produced in the
5.4.7 Inflation Based on the CPI vs WPI
- Inflation in all major indices largely followed each other. The gap between WPI and CPIs had widened in 2009-10, due to higher food inflation as food items have a much larger weight in CPI vis-a-vis the
- Food items contribute a weight of 20% in CPI-IW and 69.15% in CPI-AL as against 24.31% in WPI.
5.5 CORE INFLATION
- Another way to analyse inflation data is by looking at core inflation, which is generally a chosen measure of inflation that excludes the more volatile categories like food and energy prices.
- The main argument here is that the Central Bank should effectively be responding to the movement in permanent component of the price level rather than temporary deviations. It is, therefore, a preferred tool for framing long- term
Change in Reporting of Inflation
- At present, the WPI for all commodities including manufactured products is released only on a monthly basis. However, until recently WPI for primary articles and the fuel group was also being released on a weekly basis. But, it was observed over a period of time that there was a tendency for upward revisions in the indices reported once the final numbers were later
- The higher frequency weekly reporting was thus, prone to more statistical noise and sometimes provided a misleading picture, so the trade- off was between the more frequent and less reliable data
and less frequent, but more reliable data. International practice for reporting CPI inflation is also on a monthly basis.
- In view of this, the Cabinet Committee on Economic Affairs (CCEA) in its meeting held on 24th January, 2011, agreed to discontinue the weekly release of WPI for the commodities. Items under the groups primary articles and fuel and power with immediate effect. WPI shall, henceforth, be released on a monthly basis
5.6 MEASURES TO CHECK INFLATION
- The handling of India’s inflation challenge consists of a careful combination of effort on the part of the RBI and government, including the Ministry of Finance and several other ministries, along with advisory support by the Inter-Ministerial Group (IMG) on
- The IMG on inflation recommended several steps for improving supply chains from
the farmer to the consumer. It recommended amending the Agricultural Produce Marketing Committee (APMC) Acts in order to cut down on the large middleman price margin. It also recommended that one way to improve the supply chain and benefit farmers is to allow FDI in multi-brand retail.
- The IMG argued that if this was permitted within a carefully crafted regulatory framework, there could be large gains for farmers and also for ordinary consumers.
- The fiscal measure, the administrative measure and the monetary measure are the three different ways to contain inflation.
5.6.1 Fiscal Measures
- Fiscal policy can be effectively employed to check inflation. Manipulation of public expenditure, taxation and public debt can be used for this purpose.
- Government can spend more money in the developmental
sphere to increase supply by improving productivity. Tax incentives can also be used to improve the supply situation.
5.6.2 Administrative Measures
- The authority to take decisions on this front is with the executive branch of the
- Under this measure, they
- remove levy obligations in respect of imported
- ban export of constrained materials.
- maintain the central issue price, particularly for rice and wheat.
- suspend future
- allot rice and wheat under Open Market Sale Scheme (OMSS) and many
5.6.3 Monetary Measures
- Monetary measures come under the purview of Reserve Bank of India (RBI), Through, the Monetary Policy review, RBI tries to control price rise and maintain economic growth and financial stability.
5.6.4 Role of RBI to Curb Inflation
- Reserve Bank of India is the Central Bank of the country. Thus, it is armed with Monetary Policy with three objectives; controlling inflation, encouraging growth and financial
- In India, Monetary Policy instruments typically consists of Repo-Rate, the Cash Reserve Ratio, SLR and some other occasional interventions, like Open Savings Bank Interest Rate Policy, which may or may not be construed as Monetary
- When the RBI raises any of these rates (i.e., CRR, SLR, repo/reverse-repo, bank rate etc) money supply in economy is reduced. Reduced money supply reduces demand and thus, brings down inflation. Reducing the policy rates on the other hand leads to increased demand and higher
- On the recommendations of the Narasimham Committee, RBI
reduced CRR and SLR in a phased manner and does not vary them often for the purpose of Monetary Policy. Repo and reverse-repo now the primary tools of the bank to control money supply and inflation.
- RBI manages the exchange rates fluctuations to cope with the exchange rate sensitive
- In this case, when RBI wants to devalue the rupee they may intervene in the foreign exchange market by using rupee to buy up foreign currency or conversely, if they want to revalue the rupee, they may intervene by selling off foreign exchange
UPSC Previous Year Questions :
- With reference to inflation in India, which of the following statements is correct? (CSE 2015)
- Controlling the inflation in India is the responsibility of the Government of India only
- The Reserve Bank of India has no role in controlling the inflation
- Decreased money circulation helps in controlling the inflation
- Increased money circulation helps in controlling the inflation
- Which of the following brings out the ‘Consumer Price Index Number for Industrial Workers’? (CSE 2015)
- The Reserve Bank of India
- The Department of Economic Affairs
- The Labour Bureau
- The Department of Personnel an
- Which one of the following is likely to be the most inflationary in its effect? (CSE 2013)
- Repayment of public debt
- Borrowing from the public to finance a budget deficit
- Borrowing from banks to finance a budget deficit
- Creating new money to finance a budget deficit Government
Borrows from Banks
- Consider the following statement :
- Inflation benefits the
- Inflation benefits the bond- holders. (CSE 2013)
Which of the statements given above is/are correct?
- 1 only
- 2 only
- both 1 and 2
- Neither 1 nor 2
- India has experienced persistent and high food inflation in the recent past. What could be the reason? (CSE 2011)
- Due to a gradual switch over to the cultivation of commercial crops, the area under the cultivation of food grains has steadily decreased in the last five years by about 30%.
- As a consequence of increasing incomes, the consumption
patterns of the people have undergone a significant change.
- The food supply chain has structural
Which of the statements given above are correct?
- a) 1 and 2 b) 2 and 3
- c) 1 and 3 d) 1, 2 and 3
- Economic growth is usually coupled with (CSE 2011)
- Deflation b) Inflation
- c) Stagflation d) Hyper-inflation
- Which one of the following statements is an appropriate description of deflation? (CSE 2010)
- It is a sudden fall in the value of a currency against other currencies.
- It is a persistent recession in both the financial and real sectors of
- It is a persistent fall in the general price level of goods and services.
- It is a fall in the rate of inflation over a period of
- In the context of Indian economy, consider the following pairs: Term Most appropriate description (CSE 2010)
- Melt down — Fall in stock prices
- Recession — Fall in growth rate
- Slow down — Fall in GDP
Which of the pairs given above is / are correctly matched?
- a) 1 only b) 2 and 3 only
- c) 1 and 3 only d) 1, 2 and 3
- With reference to India, consider the following statements: (CSE 2010)
- The Wholesale Price Index (WPI) in India is available on a monthly basis
- As compared to Consumer Price Index for Industrial Workers (CPI(IW)), the WPI gives less weight to food articles. Which of the statements given above is/are correct?
- 1 only b) 2 only
- c) Both 1 and 2d) neither 1 nor 2