Benefits of inflation
Can inflation have positive consequences? The answer is yes although much depends on what else is happening in the economy. Some of the potential advantages of benign inflation are as follows:
- Higher revenues and profits: A low stable rate of inflation of say between 1% and 3% allows businesses to raise their prices, revenues and profits, whilst at the same time workers can expect to see an increase in their pay packets. This can give a psychological boost and might lead to rising investment and productivity.
- Tax revenues: The government gains from inflation through what is called ‘fiscal drag effects’. For example, many indirect taxes are ad valorem in nature, e.g. VAT at 20% – so as prices rise, so does the amount of tax revenue flowing into the Treasury.
- Cutting the real value of debt: Low stable inflation is also a way of helping to reduce the real value of outstanding debts – there are many homeowners with huge mortgages who might benefit from a period of inflation to bring down the real burden of their mortgage loans. The government too might welcome a period of higher inflation given the huge level of public sector debt!
- Avoiding deflation: Perhaps one of the key benefits of positive inflation is that an economy can manage to avoid some of the dangers of a deflationary recession (discussed in the next chapter)
Measurement of Inflation (WPI & CPI)
Whole Sale Price Index
- It is used to depict the general rate of inflation in the economy, generally, the economic policy of the government is based on this.
- It is based on the wholesale price of the selected commodity from the selected market.
- It is measured or constructed monthly, till 2009 it was constructed weekly.
- It is constructed by the economic advisory under the Ministry of Industry and Commerce.
- Is it a limitation not to include services in WPI?
It is impossible to calculate, we can’t store services so practically not possible.
- What is base year for WPI?
On the recommendation of Professor Abhijit Singh in 2010, it was changed to 2004 -0 5
- What should the criteria for giving weight age to WPI?
Normally the contribution in GDP but also the contribution of goods in production. Till 2011, Food and Fuel inflation with WPI was estimated weekly, now it is estimated monthly.
- How we measure inflation on the basis of WPI?
It is measured by point to point method where inflation is compared with the corresponding period of the same time. For example, in May 2013 it was 171.6 so we would take the value of May 2012 in order to get this value we will calculate
The formula of inflation rate – (WPI May 2013 – WPI May, 2012/WPI May 2012) * 100
It will be – (171.6 – 163.9/163.9) * 100 = 4.7%
- What is the importance of base year?
Higher the value of the base year, higher will be the value of WPI
Consumer Price Index
- What is CPI and what is its use
- It is used to show the impact of inflation on people. It shows an increase in the cost of living.
- It is used for granting the DA, to provide the same standard of living.
- It is based on retail prices of the selected commodity from the selected market.
- It is estimated at the monthly interval and constructed for 4 groups of consumer.
- Industrial workers
- CPI for urban Non-Manual employees
- CPI for agricultural labourers
- CPI for rural labourers
- Why we use it differently for different groups?
The rate of inflation impact differently for different people, so we should use it accordingly.
- CPI (IW) – Estimated by the ministry of labour, here weight age of food is high which is 46%
- CPI (UNME) – Use to grant DA and also for few Indian companies. The base year is 1984 – 85.
- CPI (AL) – Used for fixation of minimum wages, for example in MANREGA. It is used for revision of wages under MANREGA. Here base year is 1986 – 87.
- CPI (RL) – Used by some state government for the fixation of minimum wages along with CPI (Al)
3 New CPI by CSO in 2011 was introduced by CSO for weight age and items of commodity
- CPI – (Urban)
- Urban (Rural)
- Mixed (combined)
- Here base year was 2010, as per the data provided by NSSO of 61st
- Why CSO has introduced new CPI
- Because it shows the impact on broad consumer group. Earlier we don’t have any such method
PPI (Producer Price Index)
It measures inflation from the perspective of producers. It takes into account only the cost of production of firms, it ignores transportation cost and traders profit margin.
India Inflation rate
- The inflation rate in India was recorded at 5.11 per cent in January 2015.
- Inflation Rate in India averaged 8.87 per cent from 2012 until 2015, reaching an all-time high of 11.16 per cent in November of 2013 and a record low of 4.38 per cent in November of 2014.
- Inflation Rate in India is reported by the Ministry of Statistics and Programme Implementation (MOSPI), India.
- Historically, the wholesale price index (WPI) has been the main measure of inflation in India.
- However, in 2013, the governor of The Reserve Bank of India Raghuram Rajan had announced that the consumer price index is a better measure of inflation.
- In India, the most important category in the consumer price index is Food and beverages (45.86 per cent of total weight).
- Housing accounts for 10 per cent; Transport and communication for 8.6 per cent; Fuel and light for 6.84 per cent;
Source – WPI data, until December 2014
- Inflation is a situation wherein there are continuous increases in the price level of goods and services in an economy over a period of time.
- In a layman language inflation, could be defined as too much of money charged for few goods or products.
- The Indian economy has experienced robust growth since 2003-04 to date.
- However, while the first three years in this period showed moderate inflationary pressures, the last two years have experienced relatively high inflation.
- In terms of wholesale prices, inflation began to firm up mid-2006-07, mainly due to (i) an increase in the prices of wheat, pulses and edible oils because of the shortfall in domestic supply relative to demand and firm international prices; and (ii) an increase in prices of international crude.
- The RBI continued to follow its policy of gradual withdrawal of monetary accommodation in order to able to stabilise using inflationary expectations.
- During 2005 to 2008 there was a high increase in forex and also food inflation was very high, the government was under compulsion to reduce the deficit.
- In 2008 – 09, there was the subprime crisis and the bank started giving the large grant of loans.
- It had adversely affected the Indian economy, FII has withdrawn investment by the sale of shares in Bombay Stock exchange.
- Sensex fall sharply, the rupee depreciated, forex reduced, there was a decrease in money supply and aggregate demand reduces. Hence GDP growth falls down.
- It also affected IT and export sector.