Inflation is referred to as sustained rise in general price level over a given period. Inflation is categorized as low or moderate inflation. If inflation is very high, then it is termed as hyperinflation.
Inflation is the key macro variable that deals with price level movement over a period. In India, there are two major indices that measure the inflation level:
- Wholesale Price Index
- Consumer Price Index
Wholesale Price Index
The wholesale price index is the price of a representative basket of wholesale goods. In India, wholesale price index is calculated by the Government on monthly and yearly basis. There are three major groups in India’s wholesale price index:
- Primary Articles
- Fuel, Power, Lights & Lubricants and
- Manufacturing Items.
Major Groups in Wholesale Price Index of India
- Primary Articles (3 sub-groups)
- i) Food Articles
- ii) Non-Food Articles
- Fuel, Power, Light & Lubricants (3 sub-groups)
- iv) Coal
- v) Mineral oils
- vi) Electricity
III. Manufactured Products (12 sub groups)
vii) Food Products
viii) Beverages, Tobacco & Tobacco Products
- ix) Textiles
- x) Leather & Leather Products
- xi) Wood & Wood Products
xii) Paper & Paper Products
xiii) Rubber & Plastic products
xiv) Chemicals & Chemical Products
- xv) Non-Metallic Mineral products
xvi) Basic Metals, Alloys & Metal Products
xvii) Machinery & Machine tools Transport Equipment & parts
xviii) Transport Equipment & Parts
The commodity basket for the computation of WPI consists of 435 commodities, of which 98 are under primary articles, 19 under ‘Fuel, Power, Light and Lubricants’ and 318 under manufactured products.
The change in price level of these commodities is monitored, and any rise in the index value is termed inflation rate which is expressed in percentage terms. The data is released every month and expresses the previous month changes.
Consumer Price Index
The Consumer Price Index represents the basket of essential commodities purchased by the average consumer – food, fuel, lighting, housing, clothing, articles etc. Inflation measured by using CPI is called consumer price inflation. The food and beverages prices accounts for highest weightage in the index at around 48%.
Inflation could be bought by about a rise in input prices such as food, fuel, electricity tariffs or could be triggered by demand as a result of a rise in income.
Cost Push Inflation
Cost push inflation is inflation caused by an increase in prices of factors of production i.e labour, raw material, etc.The overall price level increases due to higher costs of production which reflects in terms of increased prices of goods and commodities which majorly use these inputs. While the demand remains constant, the prices of commodities increase causing a rise in the overall price level.
Demand pull inflation
Demand-pull inflation is when aggregate demand for a good or service is more than the aggregate supply. It starts with an increase in consumer demand. Typically, sellers meet such an increase with more supply. But when additional supply is unavailable, sellers raise their prices. That results in demand-pull inflation. Demand-pull inflation simply means that aggregate demand has been ‘pulled’ above what the economy is capable of producing in the short run.
Deflator measures the difference between current and constant price GDP and its components. It measures the overall nation price changes. For example if GDP rises by 8% in real term and 6% in nominal terms, the implied economy-wide rate of inflation is 2%.
Deflator is calculated in index form if current and constant price data are available.
Deflators are valuable for identifying trends and obtaining advance warning of price changes in many area. They do not tend to fluctuate much as compared to CPI and WPI indices.
Impact of Inflation on macroeconomic variables
Persistently high inflation in a country leads to depreciation of a currency in a country. Depreciation of the currency of a country means decrease in the value of the currency of a country relative to the currencies of country B. In other words, if country A, persistently experiences higher inflation than country B, in exchange for the same number of units of Currency A, the residents of country A will get fewer units of currency B than before.
Exports and Imports
As stated in the preceding paragraph, relatively higher inflation in a country leads to the depreciation of its currency vis-a-vis that of the country with lower inflation. Hence trading activities become more expensive for country with high inflation as importing goods get costlier. Also commodities produced by the higher inflation country will lose some of their price competitiveness and hence will experience lesser exports to the country with lower inflation.
When the price level rises, each unit of currency can buy fewer goods and services than before, implying a reduction in the purchasing power of the currency. So, people with surplus funds demand higher interest rates, as they want to protect the returns of their investment against the adverse impact of higher inflation. As a result, with rising inflation, interest rates tend to rise. The opposite happens when inflation declines.
There is an inverse relationship between the rate of unemployment and the rate of inflation in an economy. This inverse relationship between unemployment and inflation is called the Phillip’s Curve. The theory states that with economic growth comes inflation, which in turn should lead to more jobs and unemployment, since there will be a higher need for factors of production as levels of production is increased. This theory stands true unless there a case of stagflation. Stagflation occurs when an economy experiences stagnant economic growth, high unemployment and high price inflation.