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Inflation

INFLATION
Inflation is a condition which is characterized by a sustained and unchecked rise in the
general prices of the commodities and fall in the purchasing power of the currency and
when this phenomenon is observed over a long period of time, it is known as Inflation.
DEFLATION
Deflation is the condition in which the overall prices of the commodities decrease, and there
is a high rise in the purchasing power of the currency, which leads to the negative inflation;
it is known as deflation.
REFLATION
It is a deliberate policy adopted by the Government, at a time when the economy is passing
through a period of slowdown or recession, by increasing the money supply in the country
or by reducing the taxes in the country in order to bring back the economy to the track.
RECESSION
It is a type of condition when in a country the general prices of the commodities decrease
and the purchasing power of the currency increases and on the other hand there is lack of
liquidity in the market, it is known as Recession. The sectors of the economy which is most
affected during the recession are real estate, insurance, banking, IT etc.
DISINFLATION
Means a situation of fall in the rate of Inflation or we can say when there is a slowdown in
the rate of increase of the general prices of the goods and services in a country.
STAGFLATION
It is a type of condition where, in a country, both inflation as well as recession, coexists at
the same time, and there is also unemployment in the country it is known as Stagflation.
CORE INFLATION
It means inflation which does not take into account inflation in food articles and
fuel/energy.
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GALLOPING/HYPER INFLATION
It is a type of condition when in a country the rate of inflation rises so much that the people
of the country loses faith in the currency of the country and the government may think of
using the alternate currency or finally switching over to the barter system.
Measurement of Inflation
Inflation in India is measured on the basis of WPI and CPI on a monthly basis.
Wholesale Price Index
● Also called Headline Inflation
● Constructed by Dept. of Promotion of Industry and Internal Trade.
● 697 Commodities – Base year: 2011-12
● WPI does not include Services.

Consumer Price Index

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● CPI is constructed by NSO on the basis of the data collected from the major retail
markets of India.
● Rural areas – 448 commodities, Urban areas – 460 commodities
● Base year: 2012 and CPI includes Services.
● This index is based on five major groups of commodities.
● Group I: Food and Beverages (46%)
● Group II: Clothing and Footwear (6.5%)
● Group III: Housing (10%)
● Group IV: Fuel and light (7%)
● Group V: Tobacco, Paan and other intoxicants (2.4%)
● Miscellaneous Group: Health, Education, Transport, etc. (28%)

Divergence between CPI and WPI:

1. Composition of Indexes
2. Weightage of food articles
3. Inclusion/Exclusion of Services
4. Consumer Prices and Wholesale prices
Producers Price Index
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● Recommended by B.N. Goldhar

● Objective: To adopt corrective measures at the producer's level itself if prices start
rising at this level so that these measures can minimize the impact of rising prices
before they reach the consumer level.
Services Price Index
● Recommended by C.P. Chandrashekhar Committee.
● It is being developed by CSO on an experimental basis for four services: Railways,
Postal, Telecom, Banking Sector
GDP Deflator
● It is a measure of the change in prices of all final goods and services produced in the
current year in an economy.

GDP Price Deflator = (Nominal GDP ÷ Real GDP) × 100

● This ratio helps show the extent to which the increase in gross domestic product has
happened on account of higher prices rather than increase in output.
Causes of Inflation
There are two points of view to look at the economy, one is at the production end, and the
other is at the level of consumer, i.e., at the consumption end. For inflation in the prices of
the products, both these factors can be responsible.
At first, looking at the production end, inflation is due to:
● Increase in cost of production (input, wages, etc.)/distribution (conveyance cost),
and/or;
● Breakdown of the supply chain, e.g., rotting of the output (say tomato or other
agricultural goods)
These factors sum up as cost-push factors.
Now, looking from the end of the consumer:
There is only one factor in play, i.e., an increase in the quantity demanded. This increase is a
result of multiple factors which ultimately lead to a rise in the prices of the commodity. This
kind of inflation in prices is referred to as demand-pull inflation.
In today’s dynamic world, both these factors are in play leading to inflation. But given the
current Indian scenario of the low level of employment and related low wages, the main
factor leading to inflation is the cost-pushed one.
Demand-Pull Factors/Causes
● Rise in Population: As numbers increase, there are more mouths to feed, which lead
to a rise in the demand for goods.
● Increase in income and wages: When disposable income increases, the consumption
of goods also increases, which leads to an increase in quantity demanded.
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● Changing Consumption Patterns: Over time, people of any country tend towards
lifestyle changes, e.g., people of India have shifted from carbohydrate-rich food to
protein-rich diet. This shift has resulted in increasing the demand for these newly
preferred items.
● Black money: RBI’s monetary policy aims to ensure the quantum of money supply in
the economy, but a certain amount of money which is hidden from the records of
authorities circulate in the marketplace, leading to an increase in the actual money
supply. Hence more amount of money starts chasing fewer goods resulting in
demand-based inflation.
● Increase in money supply due to fiscal deficit: Fiscal deficit reflects the government’s
borrowing requirements. Majority of the government spending is over revenue
expenditure, including subsidies, administration costs, defence expenditure, etc. All
these expenditures do not lead to the creation of assets, and thereby, this increased
expenditure increases the money supply in the economy. This also leads to an
increase in the income levels, which in turn increases the demand for the
commodities.
● Increase in Govt. Expenditure: Government needs different products for governance
purposes. For this, the government acts as a consumer of different products and
hence increases the consumption in the economy. As a result, the government
increases the aggregate demand leading to demand-pull inflation.
● Increase in Forex reserve: RBI maintains the forex reserve. RBI in the process of
buying the foreign currency gives out Rupee in the market, which increases the
liquidity of the domestic currency. More money in the market would then lead to
more demand in the market.
Cost-Push Factors/Causes
● Infrastructure bottlenecks: Lack of infrastructure compels producer to invest more in
the strengthening of the infrastructural setup. This increases the per-unit price.
Example: buying generators to check the issue of frequent power-cuts.
● Hoarding, Speculation and Black marketing: Future speculation of prices encourages
the seller to create artificial shortage by continuously hoarding the good, hence
leading to increased costs. Again, by selling the goods at rates higher than the
marked prices, these sellers further increase the prices of commodities.
● Rise in Administered Prices: These prices like MSP, Railway prices are fixed by the
administration. Government’s perspective about the increased cost of production/
services-providing percolates through other private producers/service-providers,
which leads to an increase in overall prices of goods and services.
● Seasonal Factors: Agricultural production in India depends heavily on monsoon,
which increases the cost of production during both floods & droughts.
● Import cost-push factors: For any economy to run smoothly, few goods like crude oil,
machinery, chemicals, etc., are crucial. A rise in the importing cost of these critical
factors, e.g. crude oil, leads to an overall increase in the price of goods of associated
industries.
● Demand for increase in income and wages: From the point of view of the producer,
the hike in the salaries of the workers of the enterprise would lead to an increase in
the per-unit price.
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● Role of middlemen and intermediaries: Intermediaries like wholesalers often

arbitrarily increase their profits which leads to an increase in the prices in the
market.
● Depreciation of Rupee from time to time: With the depreciation in the value of
Rupee, the imports become costlier for a nation which pushes up the general level of
prices of goods associated with these imports. This leads to cost-push inflation.
Measures to control Inflation:
1. Strict monetary policy by the RBI: RBI follows a contractionary monetary policy to
control inflation prevailing in the economy. In this, RBI increases the Repo rate, and
government securities are auctioned to absorb excess Rupee. This is referred to as
Policy of Credit Squeeze & Dear Money Policy.
2. Strict fiscal policy by the Government of India: Government controls inflation either
by reducing private spending or by decreasing government expenditure, or both. It
reduces private spending by increasing taxes on private businesses. If direct taxes on
profits are raised, the total disposable income will reduce. As a result, the total
expenditure of individuals decreases, which, in turn, reduces the money supply in
the market and hence, curbs inflation.
3. Strict administrative measures such as:
a) Imposing a temporary ban on exports to speed up the supply
b) Liberalizing the import duty in order to speed up the supply
c) Strict penalty on black marketing
d) Imposing ESMA (Essential Services Maintenance Act) to prevent strikes and
improving the storage and distribution infrastructure of essential goods
e) Control of population through family planning