Know More about Inflation - FAQ

Inflation is a measure of rise in general price levels of goods and services.

Inflation is measured by taking a set of goods and services, and then the prices of the items in the set are compared to prices one time period ago.

In India, inflation is measured based on the wholesale price index (WPI) which measures the change in prices of a selection of goods at wholesale prices. Inflation is primarily of two types - inflation due to cost push and inflation due to demand pull (supply side). Cost push inflation is due to rise in costs of input materials or labour, whereas demand pull inflation is due to increase in demand beyond installed capacity.

Controlled inflation is good for the economy as it increases motivation levels of people. The government, in consultation with the Reserve Bank of India, decides the inflation threshold in the country (current inflation threshold range in India is 4-5 per cent). The inflation target is one of the key parameters that go into determining fiscal and monetary policies.

Inflation went up quite a bit in the beginning of last year (around seven percent) on the back of high liquidity in the markets (huge funds inflows in the form of FII and FDI). The RBI controlled inflation by tightening the monetary policy (raising cash reserve ratio and interest rates) and letting the rupee appreciate against foreign currencies.

More:

» What is a price index?

If you need to know how much the price of a particular commodity has increased in, say, the last year it is a simple enough computation. However, if you need to give a figure for the increase in prices over a range of commodities, things obviously get more complicated, since individual commodity price variations are likely to be quite different. You could choose to say the price rise ranges from, say, 4% to 26%, but that is clearly less meaningful than if you could put a single number to it and say prices have on the whole risen by 8.3%.

The purpose of a price index is to let you do just that. It does that by assigning different weights to prices of various commodities, so that you can get a weighted average of the price increases. The weights are needed because you surely wouldn't want the price of a tube of shaving cream ticket to be equated in importance with the amount you spend on petrol over a month.

» Why do we need so many price indices?
There are different levels at which prices can be measured. The price of your vegetables is different for the wholesaler who buys it from the farmer, the retailer who gets it from the wholesaler and for you. We need different indices, therefore, to measure what is happening to prices a each of these levels. In India we have the wholesale price index (WPI) to track wholesale prices, as its name suggests, and three different consume price indices to track prices facing different categories of consumers — industrial workers, urban non-manual employees and agricultural workers.

The different CPIs are needed because the prices facing different consumer groups are different. Thus, while urban house rents may be of great significant to the first two groups, they would be of no consequence to farm labour. Thus the composition of each CPI is different and should ideally reflected the actual consumption patterns of the relevant consumer groups.

» What is the inflation rate we keep reading about?
What is generally reported is the annual point-to-point inflation rate, which measures the change in the level of a price index over a full year. The CPIs in India are computed on a monthly basis, while the WPI is computed every week. Unless otherwise indicated, the inflation rate being referred to is normally the one based on the WPI. The year in this case would be 52 weeks.

Thus when the papers report that inflation for the week ended July 24, 2004 was 7.5%, what this means is that the WPI for that week was higher by 7.5% than the one for the week ended July 26, 2003. It is important to realise that the point-to-point inflation rate reflects only the difference in prices over two specific weeks. Hence, if the inflation rate moves up from one week to the next, it need not mean that prices have actually moved over that period.

It may equally be because there was a fall in the corresponding period of the previous year. This also explains why economists prefer to deal with average annual inflation rates rather than with point-to-point rates. Since the former involve averages of the index over longer periods,
temporary blips are evened out, giving a more realistic picture of the trend.

» What is the composition of the WPI?
The WPI has an All Commodities Index, which consists of four three major groups - Primary Articles; Fuel, Power, Light & Lubricants; and Manufactured Products. These are again broken up into smaller sub-groups. For instance, the primary articles group would have food articles, non-food articles and minerals. Each of these sub-groups would have several individual commodities in them.

All told, the current WPI tracks prices of 435 commodities, of which 98 are primary articles, 19 fall in the fuel, power, light & lubricants group and 318 are in the manufactured products group. The WPI has been periodically revised from the time it was first constructed in the 1930s and for obvious reasons the weights have moved progressively in favour of manufactured products.
The current index, which uses 1993-94 as its base year, has weights of 22.025 for primary articles, 14.226 for fuel etc and 63.749 for manufactured products.

Source: ET, TOI, REDIFF

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