Inflation: Meaning, Types, Impact & Measurement

• Context (IE): India’s inflation rate in November 2024 came in at 5.5 per cent.

What is Inflation?

• Inflation is the rise in the general level of prices of goods and services in an economy over a period of time.
  1. Headline Inflation: Inflation is due to all types of commodities in the economy.
  2. Core Inflation: Inflation excluding food and fuel items.

Inflation target in India

• Under the RBI Act, the GoI, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index (CPI) every five years.
• Current Inflation target is 4% with a band of 2% (2% to 6%).
• RBI’s Monetary Policy Committee (MPC) decides the repo rate based on CPI.

Also, read > Inflation targeting framework

Types of Inflation

Based on Causes

Demand-Pull Inflation

• It occurs when aggregate demand in an economy exceeds the available supply of goods and services.
• Demand-pull inflation is often associated with strong economic growth, increased consumer spending, and excessive monetary expansion.

Cost-Push Inflation

• It is driven by increased production costs, such as wages or raw material prices, which are then passed on to consumers.
• Cost-push inflation can lead to a decrease in real wages and consumer purchasing power.

Structural Inflation

• It arises from long-term imbalances in the economy’s structure, such as supply constraints, inefficiencies, or structural rigidities.
• It is typically caused by factors like limited productive capacity, inadequate infrastructure, or barriers to competition.

Imported Inflation

• It occurs when:
  1. Prices of imported goods and services rise due to changes in exchange rates, commodity prices, or trade policies.
  2. A depreciation in the domestic currency raises the cost of imported goods.
• Countries heavily reliant on imports may experience imported inflation when prices rise globally.

Built-In Inflation

• Also known as wage-price spiral or internal inflation, it refers to a self-perpetuating cycle of rising prices and wages.
• It occurs when workers demand higher wages to keep up with the increasing cost of living, and businesses, in turn, increase prices to compensate for higher labour costs.
• This reciprocal process leads to a continuous upward spiral of prices and wages.

Greedflation

• It refers to a situation where excessive greed and speculative behaviour contribute to rising inflationary pressures in an economy.
• It implies that inflation is driven not only by economic fundamentals but also by excessive profit-seeking motives and speculative activities.

Based on the Rate of Inflation

Creeping Inflation

• It occurs when prices increase at a slow and steady rate over time. This type of inflation is usually considered normal and manageable and does not significantly impact the purchasing power of consumers.
• It is often seen as a sign of a healthy economy, as it encourages spending and investment without creating instability.

Walking Inflation

• It is when prices rise at a moderate pace, higher than what is generally considered acceptable.
• It begins to erode the purchasing power of money, making it more expensive for people to buy goods and services. Over time, it can discourage savings, as the value of money saved diminishes when returns on investments fail to match the inflation rate.

Galloping Inflation

• It occurs when prices rise at a rate exceeding 10% but remain below hyperinflation levels. This type of inflation creates significant economic instability, discouraging investment and savings.

Hyperinflation

• Hyperinflation is extreme and rapid inflation where prices increase at an extremely high rate.
• It typically occurs due to a severe loss of confidence in the currency, often triggered by excessive money supply, political instability, or unsustainable fiscal policies.
• Hyperinflation erodes the currency’s value rapidly, leading to an economic breakdown.

Measurement of Inflation

Consumer Price Index (CPI)

• It calculates the average selling price of goods and services at the customer level.
• Base Year: 2012.

Commodities weights under CPI (in %)

Types of CPI

Consumer Food Price Index (CFPI)

• Measures change in retail prices of food products.
• Released by the NSO.
• Base year: 2012.

Wholesale Price Index (WPI)

• It captures the average change in wholesale prices of goods.
• Reckons only basic prices and does not include taxes, rebate/trade discounts, transport, etc.
• Released by Office of Economic Advisor (Ministry of Commerce and Industry).
• Base year: 2011-12.
• Primarily used as a GDP deflator.

Commodity weightage under WPI

GDP Deflator (Implicit Price Deflator)

• Ratio of value of goods and services an economy produces in a particular year at current prices to that of prices that prevailed during the base year.
• More comprehensive as it covers the entire range of goods & services produced in the economy.

CPI vs WPI vs GDP Deflator

Producer Price Index (PPI)

• The Producer Price Index (PPI) is an economic indicator that measures the average price changes that producers receive for their goods and services at various production stages.
• It focuses on the producer’s price perspective, not the consumer’s. It captures producers’ prices before additional costs like taxes, transportation, and retail markups are added.
• The PPI excludes the taxes, transport, trade margins, and other charges imposed when those products reach consumers or are used as inputs to other producers. In other words, it is the suppliers’ price.

Impacts of Inflation

• Erosion of Savings: Due to the rise in prices, goods and services become more expensive. Rising prices reduce the real value of saved money over time. This discourages long-term savings and can lead to fewer funds available for investment in the economy.
• Impact on debtors and creditors: Borrowers benefit because inflation reduces the real value of their fixed-rate debt. Lenders lose as price rise erodes the purchasing power of the money they are repaid, thus discouraging lending.
• Unfavourable Balance of Payment (BoP): High prices reduce exports and increase imports in the economy, resulting in an unfavourable Balance of Payment (BoP).
• Consumer Uncertainty about future costs and savings leads to reduced consumer spending and lower business investments, impacting economic growth.