Why in news: Retail inflation fell to a 77-month low of 2.1% in June, driven by easing food and crude oil prices.
Inflation – Overview
- Inflation is the rise in general price levels over time, reducing purchasing power.
- Measured using indices like Consumer Price Index (CPI) and Wholesale Price Index (WPI).
Deflation
- Opposite of inflation.
- Prices fall, and purchasing power increases.
Types of Inflation
A. Based on Rate
Creeping Inflation (Mild)
- Price rise < 3% annually.
- Considered stable and manageable.
- May encourage consumption and investment.
Walking Inflation (Trotting)
- Price rise between 3%–10% per year.
- Economy starts to overheat; needs monitoring.
Galloping Inflation (Running)
- Price rise between 10%–50% annually.
- Disturbs economic planning and erodes savings.
Hyperinflation
- Price rise > 50% monthly.
- Currency loses value rapidly (e.g., Zimbabwe, Weimar Germany).
- Leads to economic collapse.
B. Based on Causes
Demand-Pull Inflation
- Caused by excessive demand over available supply.
- Often due to increased money supply, government spending, or rising incomes.
Cost-Push Inflation
- Caused by rising input costs like wages, fuel, raw materials.
- Leads to higher prices even if demand remains constant.
Built-in Inflation (Wage-Price Spiral)
- Workers expect higher inflation → demand higher wages → producers raise prices → cycle continues.
Structural Inflation
- Caused by deep-rooted supply-side problems like poor infrastructure, logistics, or monopolies.
Protein Inflation
- Refers to rising prices of protein-rich food items (pulses, eggs, meat).
- Due to rising demand and limited supply.
Fiscal Policies
- Tax cuts and increased government spending raise demand.
- If supply doesn’t match, it leads to inflation.
Measures of Inflation
1. Consumer Price Index (CPI)
- Measures price changes at the retail level.
- Includes both goods and services consumed by households.
- Represents cost of living for consumers.
- Published by: Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation (MoSPI).
- Types in India: CPI-Rural, CPI-Urban and CPI-Combined (used for inflation targeting by RBI)
2. Wholesale Price Index (WPI)
- Measures price changes at the wholesale level (between businesses).
- Excludes services; focuses on goods traded in bulk.
- Reflects producer inflation more than consumer cost.
- Published by: Office of Economic Adviser, DPIIT, Ministry of Commerce & Industry.
- Base Year: 2011–12
3. Producer Price Index (PPI)
- Captures price changes from the producer’s perspective.
- Tracks input costs and factory gate prices.
- More comprehensive than WPI in developed countries.
- Not yet officially used in India, but recommended for future adoption.
4. GDP Deflator
- Measures inflation across the entire economy.
- Includes all goods and services produced domestically (not just a fixed basket).
- Reflects broadest measure of inflation.
- The GDP Deflator value is calculated using the formula: GDP deflator = (Nominal GDP / Real GDP) * 100.
Impacts of Inflation
Reduced Purchasing Power
- People can buy less with the same income, affecting living standards.
Higher Interest Rates
- Central banks raise rates to control inflation, making loans costlier and slowing investment.
Income Inequality
- Low-income groups are hit harder as essentials become more expensive.
Lower Investment Returns
- Inflation erodes real returns, especially on savings and fixed-income assets.
Weaker Export Competitiveness
- Domestic price rise makes exports costlier and less attractive abroad.
Rising Business Costs
- Input and wage costs increase, hurting profit margins and planning.
Currency Depreciation
- High inflation can weaken the rupee, making imports more expensive.
Social and Policy Pressure
- Prolonged inflation can lead to public unrest and populist economic policies.
Measures to Control Inflation
1. Monetary Policy Measures (RBI)
Inflation Targeting:
- RBI targets inflation at 4% ± 2% (as per revised monetary policy framework).
- Monetary Policy Committee (MPC) adjusts the repo rate to control inflation.
Interest Rate Hikes:
- Increasing policy rates discourages borrowing and reduces demand.
Open Market Operations (OMO):
- RBI sells government securities to absorb excess liquidity from the market.
Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR):
- Raising CRR/SLR reduces the money banks can lend, tightening money supply.
Qualitative Controls:
- Raising margin requirements or imposing credit restrictions on speculative commodities.
2. Fiscal Measures (Government)
Reduce Public Spending:
- Cutting expenditure on schemes or infrastructure reduces demand-side pressures.
Increase Taxes:
- Raising direct/indirect taxes discourages consumption and reduces liquidity.
Rationalize Subsidies:
- Targeted subsidies can limit excessive demand while containing fiscal deficit.
3. Supply-Side Measures
Boost Production:
- Encourage investment in agriculture, manufacturing, and logistics.
Improve Infrastructure:
- Better roads, cold chains, storage reduce wastage and cost-push pressures.
Remove Bottlenecks:
- Easing regulations and promoting competition lowers structural inflation.
4. Exchange Rate Policy
Strengthen Currency:
- A stronger rupee lowers imported inflation, especially for oil and food.
- RBI may intervene in the forex market to stabilize the rupee.
5. Price Controls and Subsidies
Essential Goods Regulation:
- Temporarily cap prices of food, fuel, and medicines to protect consumers.
Subsidies:
- Provide subsidies on cooking gas, fertilizers, and food grains to ease inflation burden.
6. Targeted Interventions
Use of Buffer Stocks:
- Release of grains, pulses, or onions from government reserves to curb food inflation.
Trade Policy Adjustments:
- Reduce import duties or ban exports during shortages of essential items.
7. Inflation Expectation Management
Effective Communication by RBI:
- Clear guidance helps anchor market expectations and reduces speculative behavior.
UPSC Relevance
GS Paper III: Inflation trends, monetary & fiscal policy, role of RBI, supply-side measures
Sample Mains Question
Q. Inflation control requires a balance between monetary tightening and supply-side management. Critically examine the effectiveness of India’s approach in tackling recent inflationary pressures. (250 words)
