Inflation refers to the rise in the prices of most goods and services of daily or common use, such as food, clothing, housing, recreation, transport, consumer staples, etc. Inflation measures the average price change in a basket of commodities and services over time. The opposite and rare fall in the price index of this basket of items is called ‘deflation’. Inflation is indicative of the decrease in the purchasing power of a unit of a country’s currency. This is measured in percentage.
There are two types of inflation –
- Demand Pull Inflation: Demand pull inflation arises when aggregate demand in the economy becomes more than aggregate supply.
- Cost push inflation: when there is decrease in aggregate supply of goods and services results into increase in cost of production.
- Demand Side inflation is caused by high demand and low production or supply of multiple commodities create a demand-supply gap, which leads to a hike in prices due to increase in consumption; Also, Increase in exports which undervalues rupee; Also, the excess circulation of money leads to inflation as money loses its purchasing power With people having more money, they also tend to spend more, which causes increased demand.
- Cost Pull inflation is caused by shortage of factors of production like labour, land, capital etc. and also due to artificial scarcity created due to hoarding. For example, Brent crude prices crossed $65 per barrel in May 2021, more than double of what it was a year ago. Price of vegetable oils, a major import item, shot up 57% to reach a decadal high in April 2021. Metals prices are near the highest in 10 years and international freight costs are escalating.
In India, inflation is primarily measured by two main indices — WPI (Wholesale Price Index) and CPI (Consumer Price Index), which measure wholesale and retail-level price changes, respectively. The CPI calculates the difference in the price of commodities and services such as food, medical care, education, electronics etc, which Indian consumers buy for use.
On the other hand, the goods or services sold by businesses to smaller businesses for selling further is captured by the WPI. In India, both WPI (Wholesale Price Index) and CPI (Consumer Price Index) are used to measure inflation.
- The purchasing power of a currency unit decreases as the commodities and services get dearer.
- This also impacts the cost of living in a country. When inflation is high, the cost of living gets higher as well, which ultimately leads to a deceleration in economic growth.
- A certain level of inflation is required in the economy to ensure that expenditure is promoted and hoarding money through savings is demotivated.
- Inflation is measured by a central government authority, which is in charge of adopting measures to ensure the smooth running of the economy. In India, the Ministry of Statistics and Programme Implementation measures inflation.
- RBI through its Monitory Policy Committee Controls Inflation with its tools to control Money supply in the market.
- The Central Government has notified 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016, to March 31, 2021, with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
Inflation targeting is a monetary policy in which a central bank has an explicit target inflation rate for the medium term and announces this inflation target to the public. It will have price stability as the main goal of monetary policy.
Many central banks adopted inflation targeting as a pragmatic response to the failure of other monetary policy regimes, such as those that targeted the money supply or the value of the currency in relation to another, presumably stable, currency.
- It will lead to increased transparency and accountability.
- Policy will be linked to medium/long term goals, but with some short term flexibility.
- With inflation targeting in place, people will tend to have low inflation expectations. If there was no inflation target, people could have higher inflation expectations, encouraging workers to demand higher wages and firms to put up prices.
- It also helps in avoiding boom and bust cycles.
- If inflation creeps up, then it can cause various economic costs such as uncertainty leading to lower investment, loss of international competitiveness and reduced value of savings. This can also be avoided with targeting.
- Inflation targets can have various benefits, especially during ‘normal’ economic circumstances. However, the prolonged recession since the credit crunch of 2008 has severely tested the usefulness of inflation targets
- It puts too much weight on inflation relative to other goals. Central Banks Start to Ignore More Pressing Problems like unemployment.
- Inflation target reduces “flexibility”. It has the potential to constrain policy in some circumstances in which it would not be desirable to do so.
- Cost-push inflation may cause a temporary blip in inflation.
- It cannot help remove supply bottlenecks and shortages
- It cannot help external shocks, exchange rate might suffer in the short run
- Growth and employment might take hits in the short run
- Monitory Policy : Monetary policy is one of the most commonly used measures taken by the government to control inflation. It uses tools like – Bank rate, Repo Rate, Open market operations, etc.
- Fiscal Policy : The two main components of fiscal policy are government revenue and government expenditure. In fiscal policy, the government controls inflation either by reducing private spending or by decreasing government expenditure, or by using both. It reduces private spending by increasing taxes on private businesses. When private spending is more, the government reduces its expenditure to control inflation. However, in present scenario, reducing government expenditure is not possible because there may be certain on-going projects for social welfare that cannot be postponed.
- Price Control : In this method, inflation is suppressed by price control, but cannot be controlled for the long term. The historical evidences have shown that price control alone cannot control inflation, but only reduces the extent of inflation.
Controlling inflation has been a priority area for the Central Government according to Economic Survey. Every year, Government takes number of steps to control inflation, which we can read in the Economic Survey, a dedicated chapter summarises all the government steps.
For example, in the previous years, government has taken following steps:
- Advisories are being issued, as and when required, to State Governments to take strict action against hoarding & black marketing and effectively enforce the Essential Commodities Act, 1955 & the Prevention of Black-marketing and Maintenance of Supplies of Essential Commodities Act, 1980 for commodities in short supply.
- Regular review meeting on price and availability situation is being held at the highest level including at the level of Committee of Secretaries, Inter Ministerial Committee, Price Stabilization Fund Management Committee and other Departmental level review meetings.
- Higher MSP has been announced so as to incentivize production and thereby enhance availability of food items which may help moderate prices.
- A scheme titled Price Stabilization Fund (PSF) is being implemented to control price volatility of agricultural commodities like pulses, onions etc.
- The Government approved enhancement in buffer stock of pulses from 1.5 lakh MT to 20 Lakh MT to enable effective market intervention for moderation of retail prices. Accordingly, a dynamic buffer stock of pulses of upto 20 lakh tones has been built.
- Pulses from the buffer are being provided to States/UTs for PDS distribution, Mid-day Meal scheme etc. The requirement of pulses by Army and Central Para-military Forces.
- States/UTs have been advised to impose stock limit on onions. States were requested to indicate their requirement of onions so that import of requisite quantity may be undertaken to improve availability and help moderate the prices.
Like the above measures, government takes stpes to control – DEMAND pull Inflation and COST Pull inflation.
- Official data tells us that wholesale price index (WPI)-linked inflation went double-digit at 10.5% year-on-year in April 2021 (from 7.4 per cent in March), for the first time since 2010.
- The CPI inflation, moderated to 4.3 per cent (from 5.5 per cent in March) – led by a high base of the previous year (it had spiked to 7.2 per cent in April 2020).
- The analysis of trend of Inflation should be read in ECONOMIC SURVEY of respective year, a dedicated chapter gives us a clear picture.