INFLATION

Definition:

Inflation can be defined as a rise in the general price level of goods and services and therefore a fall in the value of money. That means the purchasing power of your money decreases.

How Inflation is Calculated?

There are two methods to calculate inflation 1. Wholesale Price Index (WPI) 2. Consumer Price Index (CPI) 1. Wholesale Price Index (WPI): WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 676 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions.

Cont
The 676 commodities are divided into different groups & sub groups. Each commodity has some weightage in the WPI index. Below are the weightages of commodities group wise:
ITEMS Weightage

Primary Articles Fuel & Power Manufactured Products

20.1% 14.9% 65%

Formula:
WPI at end of year WPI at beginning of year X 100 WPI of beginning of year Example: WPI on Jan 1st 1980 is 106.09 and WPI of Jan 1st 1981 is 109.72 then inflation rate for the year 1981 is,

= (109.72 106.09) x100 =3.42% 106.09 So the inflation rate for the year 1981 is 3.42%.

Recent Changes in WPI

ITEMS Base Year (OLD 1993-94) Base Year (NEW 2004-05)

Primary Articles Fuel & Power Manufactured Products

22% 14.2% 63.7%

20.1% 14.9% 65%

Consumer Price Index (CPI)

CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation. Most developed countries (UK, US, JAPAN and CHINA) use the Consumer Price Index (CPI) to calculate inflation.

Difference between WPI and CPI

Wholesale Price index (WPI) WPI is available on weekly basis. Consumer Price Index (CPI) CPI is available on a monthly basis.

WPI contains commodities which CPI contains set of goods are not even consumed by purchased and consumed by consumers. consumers. Example: Coarse grains that go into making of livestock feed. WPI is measured in terms of price increase for the producers and traders. CPI is measured in terms of price increase for the end consumer.

Choice of a Base Year

In determining the base year for any index number, a set of well-known criteria is followed. These include: a) The base year should be a normal year, i.e., a stable year in respect of economic activities like production, trade, etc. b) It should not suffer from business cycles; c) Availability of reliable price data for the selected year. d) The base year should be as recent a year as possible so that by the time revised series of items and their prices are released, it should not have outlived its utility.

WHY 2004-05 SELECTED AS NEW BASE YEAR?

The Annual Survey of Industries (ASI) data is the primary source for the selection of the product basket and derivation of product level weights for the manufacturing group of the WPI series. The availability of the latest ASI data for the year 2004-05 was one of the major factors for considering 2004-05 as the base year for the new WPI series. The year 2004-05, being a relatively recent year, the task of collection of backlog price data from this year onwards was expected to be more manageable. Furthermore, it was a normal year, free from any major economic upheaval.

Why India uses WPI?

Finance ministry officials point out that there are many problems while shifting from WPI to CPI model. First of all, they say, in India, there are four different types of CPI indices and that makes switching over to the Index from WPI fairly risky and unwieldy. The four CPI series are: 1. CPI Industrial Workers 2. CPI Urban Non-Manual Employees 3. CPI Agricultural laborers' 4. CPI Rural labour

Cont..
Secondly, officials say the CPI cannot be used in India because there is too much of a lag in reporting CPI numbers.
The WPI is published on a weekly basis and the CPI, on a monthly basis. And in India, inflation is calculated on a weekly basis.

Types of Inflation
Demand - Pull Inflation
Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by the four sections of the macro economy - households, businesses, governments and foreign buyers.

Cost Push Inflation

Aggregate supply is the total volume of goods and services produced by an economy at a given price level. When there is a decrease in the aggregate supply of goods and services curtail from an increase in the cost of production, we have cost-push inflation

Causes of Inflation
There are various factors which cause inflation in the economy -

Monetary Factors
Expansion of Money Supply Increase in Disposable Income

Increase in Indirect Taxes

Drop in exchange Rate

Cont
Non-monetary Factors
Rising Population
Natural Calamities

Speculation and Black Money

Unfair Practices by Monopoly Houses

Bottlenecks and Shortages

Cont
Structural Factors
Capital Shortage Infrastructural Bottlenecks Limited Efficient Entrepreneurs Lack of Foreign Capital Imperfections of the Market Unemployment

Cont
Global Factors Increase in International Prices Cold War with other countries Rise in Fuel Prices

Effects Of Inflation

Positive Effect
Benefit the cartels formed by the companies Benefit borrowers Farmers Gain In Inflation Tobin effect

Negative Effect
Hoarding Increased risk - Higher uncertainties Distortion of relative prices

 Fixed income recipients will be hurt Lowers national saving Rising prices of imports Income diffusion effect Illusions of making profits

 Rising prices of imports

Existing creditors will be hurt Currency debasement Causes business cycles Causes an increase in tax bracket

Measures to control Inflation

The Various measures to control inflation are:

1.Monetary Measures
2.Fiscal Measures 3.Other Measures

Cont..
1. Monetary measures
The monetary measures which are widely used to control inflation are divided into Bank rate policy Statutory Liquidity Ratio Open market operation Repo rate

Cont
Reverse repo rate

Cash Reserve Ratio

Key Rates 2009 April, 2010 6% 5.25% Dec, 2010 6% 6.25%

CRR Repo rate

5.75% 5%

Reverse Repo rate

3%

3.75%

5.25%

Cont
Selective credit controls Moral suasion Credit authorization scheme

Fiscal Measures
Taxation
Government expenditure

Public borrowings
Protectionist measures

Other Measures
To Increase Production Price Control Rationing

Food Inflation
Food price inflation is one of the most critical economic problems in the country today. Lower agricultural growth in India compared to the much faster GDP growth.

 The high food price inflation is having a significant impact on the Indian consumer. The chart below gives the way the Indians spend.

Reasons for high Food Inflation

Low production and productivity The prevailing market inefficiencies lack of coordinated efforts in public procurement Poor distribution Wastage due to inadequate and poor storage facilities Inefficient public distribution system Speculative trading Increasing retail margins

Some Prescriptions
The release of food grain stocks together with faster distribution. Part of Foreign Exchange Reserves can be used for bulk import of essential commodities. Improving food production and productivity. Promoting Private sector Participation in Food grain Management. Stepping up investments Foreign Direct Investment (FDI) in food retailing

Inflation Chart

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