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Subjects /Indian Economy / Inflation

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Introduction
25 Feb 2021

Have you ever noticed when you go out shopping with your parents and after buying every article your Mom or Dad saying ‘Bohot Mehengai ho gai hai…’ or ‘Humare time pe 1 rupee m 5 gol-gappe aate the..

Well, that ‘Mehengai’ is Inflation.


Inflation refers to rising trends in general price level of goods and services in Economy.

In other words, as prices will go up, the value of money will go down, therefore there is an inverse relationship between them.

Vm = 1 / Pr

Vm = Value of money

Pr = Price

Causes for Inflation

Multiple causes are categorised into main 2 causes for Inflation, these are:

  1. Demand Pull Inflation
  2. Cost Push Inflation

Factors responsible for Demand Pull Inflation –

  • Decline in Production
  • Increase in Income
  • Mounting Government Expenditure
  • Liberal Credit Policy
  • Increasing exports of essential commodity
  • Increasing inflow of foreign currency
  • Black market and Hoarding of essential commodities
  • Increasing support prices of food grain by Government.
  • Constraints of supply chain due to strong presence of intermediaries in the market.
  • Increase in Population.

 

Factors responsible for Cost Push Inflation

  • Increase in Wages
  • Increase in Prices of Raw Material
  • Increasing rate of Indirect Taxes
  • Increase in Prices of Petroleum products
  • Structural bottleneck in form of power interest and strike by transporters etc
  • Reduction in subsidies
  • High rate of interest or strict credit policy.

Types of Inflation

Headline Inflation



Core Inflation

It reflects the price rise regarding manufactured commodities, which are not affected by day-to-day events.

Example: Electricity, Fuel and Manufacturing.


Open Inflation

When Inflation becomes beyond the control of Government it is called as Open form of Inflation.

Suppressed Inflation

When Government tries to control inflation through price control through rationing like mechanism this is called suppressed inflation.


Branded Inflation

Rise in local commodities due to import of International brands.

Local considered as inferior.



Protein Inflation



Creeping Inflation

When the rate of annual inflation is around 1%, it is considered as Creeping Inflation.


Walking Inflation

The rate of Inflation is 3 to 4%.

Walking Inflation is good for Economy.


Running Inflation

When the rate of Inflation is around 10%, it is called Running form of Inflation.




Hyper Inflation

High double digits rate of Inflation. (11 to 99%).



Galloping Inflation

Rate of Inflation is 100% or more.

Example: Zimbabwe’s economy is facing galloping Inflation, the Government issued - One Lakh rupees note. And now changed the currency to Dollar.


Run Away Inflation

It is last stage of Galloping inflation.



Measurement of Inflation

It is the general rise in the prices of the goods and services over a period of time.

Inflation is measured with the help of price indices and for the purpose various types of indices are prepared in India.

The index of base year is always 100.


Calculation of Inflation

Parameters

Calculated By

Base Year

WPI

DIPP

2004

CPI

CSO

2012

IIP

CSO

2004

GDP

CSO

2011

 

NOTE: IIP = Index of Industrial Production – It measures Production not Inflation.

Basket of Commodities in IIP

3 Categories

Manufacturing > Mining > Electricity

Total Component (682); Weight (1000)

Wholesale Price Index-WPI

In India at national level, fluctuations in prices of Goods and Commodities has been measured taking into view their Wholesale Prices.

For this purpose, at present a basket of 676 Commodities is taken and it has been divided into 3 categories:

  1. Primary Articles: which includes daily used commodities (102 in total) and weightage given is 20.1%.
  2. Fuel and Electricity: total 19 in number and weightage is 15%.
  3. Manufactured Commodities: number 555 with weightage 64.9%

Abhijeet Singh Committee was set up to check the ‘-ve’ inflation thing. Before 2010 – 435 commodities were there.

  • The weightage given to food/primary article in the new series of WPI, according to Angel’s Law.

Angel’s Law: This law states that as the income of a person increases, the ratio of expenditure on food articles gradually comes down as compare to other expenses and as per the fresh survey this is happening in India.

  • The base year of WPI is 2004-05
  • It is measured on weekly basis, on every Saturday of the week, but is available on monthly basis.
  • It is prepared by DIPP (Department of Industrial Policy and Promotion)

Consumer Price Index-CPI

  • Max -Weight  is   given in top  to bottom  order

1.    Food and Beverages

2.    Miscellaneous – Health education, recreation, etc

3.    Housing (not available in Rural)

4.    Fuel and Light

5.    Clothing, Footwear

6.    Pan, Tobacco, Intoxicant

Core CPI = Headline CPI – Food and Fuel


Calculation of CPI as per Old Series:

  • It is prepared to decide minimum wages and Dearnest Allowances (D.A.) of employees.
  • Under CPI, goods and services both are taken.
  • It is prepared by CSO
  • It is measured on monthly bases, that is on last Saturday of every month.
  • Following types of CPIs are prepared for the purpose:
    • CPI (AL): Consumer Price Index for Agricultural Labourers.
      • To decide minimum wages for them.
      • Wages under MNREGA are decided on the basis of this index.
    • CPI (RL): Rural Labourers.
    • CPI (IW): Industrial Workers
      • The D.A. of employees of Central Government is decided on the basis of this index.
    • CPI (UNME): for Urban Non-Manual Employees.
      • It was used to decide the D.A. of employees of Banks and Embassies, presently it is not in practice.


Calculation of CPI as per New Series:
  • In order to track fluctuations in current or market prices of Goods and Services it has been adopted.
  • It was started in 2012, taking 2010 as base year and the number of commodities equals to 200.
  • It is prepared separately for urban and rural areas.

According to Urjit Patel committee report, RBI should consider CPI as anchor rate of Inflation rather than WPI.


Reforms in CPI

  • Base Year = 2012
  • Weight assigned based on Consumer Expenditure Survey 2011
  • Weight on Household food and fuel expenditure – decreased
  • Weight on non-food expenditure = increased
  • Basket size of commodity = increased
    • Rural = 448
    • Urban = 460


On the basis of period, Inflation is measured on 2 ways:

1. The Annual Average rate of Inflation

It is the average of 52 weeks of rate of Inflation. It is available at the end of the year.

2. Point to Point Inflation rate

It measures the rate of Inflation on the basis of changes taking place between a particular week of the last year and the same week of the current year.

It could be available at any time.

Miscellaneous Price Indices

  • PPI (Producer’s Price Index)
    • WPI considers only Goods. While PPI will cover Goods and Services.
    • Inflation without Taxes (i.e., original produce), it measures Price Change from seller’s perspective.
    • Most OECD use PPI
    • It is in sync with SNA system.
    • It is recommended by Prof. B N Goldar Committee.
  • SPI (Service Performance Index)
    • Recommended by C P Chandrasekhar Committee
  • BDI (Baltic Dry Index)
    • London based Baltic exchange
    • Daily data
    • Cost to transport raw material by sea.
    • If it Increase = world’s economy grows.
    • If it Decrease = world’s economy goes through slowdown.

Impact of Inflation

Negative

Positive

  • Creditors will be in loss
  • Investment will be discouraged
  • Growth rate might come down.
  • There is a chance of forced savings
  • Poor people suffer, fixed income class and labour class also suffer.
  • Domestic currency gets depreciated.
  • Imports become costlier.

 

  • Debtors get benefited
  • Producers get benefited
  • Shopkeeper get benefited.

Measures to Control Inflation

Various measures to combat inflation can be divided into 3 main categories:

  1. Fiscal Measures
    • Measures taken by the Government like:
    • Reducing rate of Tax, Providing more subsidies, etc
  2. Monetary Measures
    • Adopted by RBI like:
    • Increasing interest rates, reducing money supply etc.
  3. Administrative Measures
    • It takes measures like:
    • Rationing, Administered Prices mechanism, controlling Hoarding and black marketing.

Important Miscellaneous

  • Deflation: Inflation below 0 is Deflation.
  • Quantity Easing (QE-3)
    • These are the mechanism to control recession.
    • Federal Bank/Reserve of America – purchased bonds worth 85 billion dollars to control the condition (recession).
    • Uses Tapering (slowing down) mechanism.
  • Reflation: due to measures adopted under recession and depression prices starts gradually increasing, that is called reflation.
  • Stagflation: Stagnation (Recession) + Inflation
    • It is the condition when both Recession and Inflation found in the Economy.
  • Dis-Inflation
    • It refers to that process under which prices are declining gradually without any adverse impact on production and employment.
  • Misery Index = rate of Inflation + Rate of Unemployment
  • Scheduled Bank
    • Those banks registered under Schedule II of RBI Act, 1934, are known as Scheduled Bank.
    • These are entitled to get all the facilities provided by RBI, i.e., Availing loan facility at Repo rate, but in turn they have to follow the rules and regulations of RBI, at present there are no non-schedule bank in India.


Did You Know

  • The one who take loan (Debtors), benefited from Inflation.
  • According to Angel’s Law as the income of a person increases, the ratio of expenditure on food articles gradually comes down as compare to other expenses. This is what happening in India in current times.