Inflation refers to the economic condition characterized by a large and sudden increase in the prices of goods and services. People are concerned about the prices of goods and services that they consume. So it has become a common practice to measure inflation as the annual percentage change in the Consumer Price Index (CPI) which is just a measure of the average price of a standard “basket” of goods and services consumed.
Q. WHAT CAUSES INFLATION?
Several types of inflation have been identified depending on their underlying causes:
Cost-push: A type of inflation characterized by the rise in prices resulting from increase in the cost of production without increases in output.
Examples of this would be hikes in international oil prices, higher cost of capital, higher interest rate, etc.
Demand-pull: This is the kind of inflation caused by higher demand compared to the available supply of goods and services. Usually, when people, business or the government receive more income etc, the overall demand for goods and services may increase. This would lead to increased prices, assuming the supply of goods and services is not able to adjust quickly enough to meet the higher demand.
Structural: A type of persistent inflation caused by deficiencies in certain conditions in the economy such as a backward agricultural sector that is unable to respond to people's increased demand for food, inefficient distribution and storage facilities leading to artificial shortages of goods, and production of some goods controlled by some people.
Q. WHAT IS THE IMPACT OF INFLATION?
ü The impact of increase in prices is a decline in the purchasing power. Thus, inflation means that households with a fixed income can buy a smaller amount of goods and services. Mostly these tend to be low- income households while higher-income households have more flexibility to neutralize inflation by investing in assets that hold their value against inflation.
ü The savings pattern may also be affected. With the declining value of money, people would be more inclined to spend than save anticipating that their money can buy even less in the future.
ü Inflation can also erode the external competitiveness of domestic products if it leads to higher production costs such as wage increases, higher interest rate and currency depreciation.
ü High inflation countries tend to have high interest rates because market participants in countries with high inflation rates tend, if the inflation is persistent, to expect high inflation. Since contracted real interest rates do not differ a lot between countries, countries with high expected rates of inflation will tend to have higher nominal interest rates than countries with low expected inflation.
ü Inflation is a tax on money. The government prints money and spends it in the economy for the purchase of the goods (labour services, supplies, etc.) it needs to produce the services it supplies to the public. When the amount of money it prints is in excess of the quantity that will maintain the price level constant, there will be inflation. In fact, the inflation will be in proportion to the excess increase in the money supply.
ü The public has given up goods (labour, supplies, etc.) to the government in return for newly issued currency. But the price level rises proportionally with this additional currency in circulation so that the real money stock remains unchanged and the real value of the addition to currency holdings is zero. The real quantity of money is unaffected by the nominal monetary expansion because the price level rises in proportion to the increase in the money supply.
Q. WHAT'S THE NATURE OF INFLATION IN INDIA?
In India we have a combination of both cost push and demand pull. For instance, the high growth in onion prices was an instance of demand pull inflation, when the shortage of onions in the market took the prices to new heights. Also, prices go up when there is a hike in prices of petroleum products. Price rise here is due to cost push factors. This is because petroleum is a vital input in many manufactured items and as an essential fuel for road transport, it adds to the transportation costs and so prices in general tend to rise.
Q. WHY DO WE FEEL THE PINCH OF RISING PRICES DESPITE LOW INFLATION?
While the inflation figures that the government publishes every week are rate of change in wholesale price index (WPI) representing rate of increase in the wholesale prices of products, what matters to us as individual buyers is the consumer price. Though prices in the wholesale market have grown at a slow pace (at about 2-3 per cent), comparatively consumer prices (measured in terms of CPI) have grown at a much faster pace (about 8-9 per cent), Hence the pinch.
Q. WHY IS THERE SUCH A DIFFERENCE BETWEEN WHOLESALE PRICES AND CONSUMER PRICES?
A substantial portion of the differential is accounted for by the retailer’s margins which are built into what the consumer pays. The way the two indices are calculated differs both in terms of weightage assigned to products as well as the kind of items included in the basket of products.
Q. WHY DOESN'T THE GOVT PUBLISH THE TREND IN CONSUMER PRICES?
While wholesale prices are more or less the same throughout the country, consumer prices or retail prices vary across regions and also across cities according to the consumer preferences for certain products, supplies and purchasing power. Besides, taxes levied by states comprise an important component of the variation in prices of many products. Therefore, it is felt that it is important to give a more representative picture that is true for the entire nation because of which the government sticks to trends in wholesale prices when it talks of inflation.
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