Inflation and Its Economic Implications

Inflation: A sustained increase in the general price level of goods and services, typically measured on a year-on-year basis.

• Price Index: A statistical measure of price changes over time, calculated against a Base Year (which is indexed to 100).

Classification of Inflation

1. Based on Rate:

• Creeping (or Mild) Inflation: A slow, manageable rate (e.g., 2-3%) considered acceptable or even conducive to economic growth.
• Walking (or Trotting) Inflation: A moderate rate (e.g., 3-10%) that serves as a warning for policy intervention.
• Galloping Inflation: A high rate (e.g., 10-50%) that harms the economy, erodes savings, and deters investment.
• Hyperinflation: An extreme, rapid rate (e.g., >50% per month), often caused by a massive increase in the money supply, leading to a collapse in the currency’s value.

2. Based on Cause:

• Demand-Pull Inflation: Occurs when aggregate demand for goods and services exceeds aggregate supply.
• Cost-Push Inflation: Results from an increase in the costs of factors of production (e.g., wages, raw materials).
• Structural (or Bottleneck) Inflation: Arises from economic deficiencies, such as inefficient supply chains, poor infrastructure, or low productivity.
• Supply-Shock Inflation: Caused by an unexpected or sudden fall in the supply of commodities.

Key Measures of Inflation in India

A. Consumer Price Index (CPI):

• Measures price changes at the retail level for a basket of goods and services consumed by households.
• Includes services.
• The CPI (Combined) is used by the Reserve Bank of India (RBI) for monetary policy targeting (based on the Urjit Patel Committee recommendation).
• Published by: National Statistical Office (NSO).
• Base Year: 2012.
• Other specific indices (CPI-IW for industrial workers, CPI-AL/RL for labourers) are compiled by the Labour Bureau for wage indexation.

B. Wholesale Price Index (WPI):

• Measures price changes at the wholesale or bulk transaction level.
• Does not include services.
• Covers Primary Products, Fuel & Power, and Manufactured Products.
• Published by: Office of Economic Advisor (Ministry of Commerce and Industry).
• Base Year: 2011-12.

C. GDP Deflator:

• A comprehensive measure calculated as the ratio of GDP at Current Prices to GDP at Constant Prices.
• It covers all goods and services produced in the economy but is not used for short-term policy as the data is released with a significant lag.

Economic Effects of Inflation

On Stakeholders:

• Gains: Borrowers (debtors), producers, and equity holders.
• Loses: Lenders (creditors), consumers, bondholders, and fixed-income groups.

On Macroeconomy:

• Balance of Payments (BoP): Becomes unfavorable as exports become less competitive and imports become cheaper.
• Exchange Rate: Leads to the depreciation of the domestic currency.
• Savings: Discourages holding cash as inflation erodes purchasing power.

Policy Measures for Control :

• Monetary Measures (RBI): Reducing the money supply by increasing interest rates or reserve ratios (CRR, SLR).

Fiscal Measures (Government):

• Reducing government expenditure.
• Increasing direct taxes (e.g., income tax) to reduce disposable income.
• Reducing indirect taxes (e.g., GST) to lower commodity prices.
• Trade Measures: Importing goods to increase domestic supply and ease price pressure.
• Administrative Measures: Price controls, anti-hoarding measures, and rational wage policies.

Associated Key Concepts

• Deflation: A persistent fall in the general price level (negative inflation).
• Disinflation: A reduction in the rate of inflation (e.g., inflation falling from 6% to 4%).
• Reflation: Deliberate government policy to increase inflation to counter a deflationary period.
• Stagflation: A combination of high inflation and economic stagnation (low growth and high unemployment).
• Headline Inflation: The total inflation in an economy, including volatile items like food and fuel. Measured by CPI (Combined) in India.
• Core Inflation: Headline inflation excluding volatile food and fuel prices. It indicates the underlying, long-term inflation trend.
• Phillips Curve: An economic model illustrating the inverse relationship between unemployment and inflation. Stagflation is an exception to this model.