Social Economic

Inflation – a multi-dimensional Problem

Almost since the new government took place in office in 2014, discussion on economic indicators tend to become highlights. Whether it is about GDP growth figures, FDI guidelines, NPA mess or Inflation figures it attracts lots of attention from media and public both. Inflation figures are somewhat more special than other economic indicators. A reason for this is the decade old tussle between the central Bank RBI and the central government. Another and a somewhat more important reason for such huge attention is a direct and immediate impact of inflation on the public. They feel it every time when goes to market, it remains fresh in their memories.

Though it is a very good sign and indicate public awareness & interests. It also creates worries, because inflation is not a simple term and has many dimensions. It is not just an economic word which can be utilize to define or make policy decision by treating it just as an indicator of prices.  People often might get misled and become victims of someone else agenda.

What is Inflation?

In very simple words inflation is the rate at which goods & service’s prices rise. Though it is not a very precise definition and might be wrong in technical terms, it will serve the purpose for now.  With this definition, we can understand that inflation affects the quantity of goods & services that can be bought. From here we can start with some basic characteristics and other impacts of it.

Higher inflation makes money less valuable, which leads to decrease in quantity of goods & services that can be bought. The impact of higher inflation is very severe on the economy. Higher inflation destroys the middle-class incomes which are saved in form of bonds and deposits, whereas industrialist’s debt will be lower in relative to products sale revenue. This leads to the income distribution distortions in the society. Another important feature of higher inflation is its variability. With higher volatility in it – production and investment planning’s become riskier.  Also, to control increase in it, the central bank will increase the interest rates. There by increasing the overall borrowing rate because of increased risks & higher interest rates for industrialists.  This further leads to lower capital investment and impacts future growth prospects in the economy. Thus we see higher inflation doesn’t affect only present but also the times to come.

The worst attribute of inflation is its self-feeding nature. Future prices affect current prices. Expectations of higher future prices lead to an increase in current prices, with rising current prices production cost gets an increase which led to increase in future prices, and the spiral continues. All these things make it the most important economic parameter for the central bank and most cautiously watched one by economists.

Inflation Measurement

There are many indices in use by economists for measuring this. CPI & WPI are two main indices of these. Among these two, it is CPI is more relevant for public discussions. The RBI, Central bank calculates CPI in three different categories – Rural, urban and combined. It has six main categories and Weights are different for different CPI. For combined CPI the weights along with category are – Food and beverages (48.24%), Clothing and Footwear (6.53%), housing (10.07%), Fuel and Light (6.84%), Pan, Tobacco and Intoxicants (2.38%), Miscellaneous (28.32%). Education (4.46%) and health care (5.89%) are included in the miscellaneous category. The figures in bracket represent the weights assigned to the category for calculation of overall inflation.

Generally, it is combined CPI which is most referred in generic discussions among public and media. And, there are problems in using any specific CPI for generic discussions.

Aggregate Nature of Inflation

If we discuss inflation in any specific sense then, the rationale behind these weights can be put to question. As we see, a Major weight is given to food category & very less to education & health. For a middle-class family living in a metro city; the weights on health and education will be out of proportion. From 2010 to 2016, there has been more than two fold increase in fees structure of all private schools and colleges. There by increasing the expenditure on health and education. Therefore, increase in CPI index will be able to explain increased expenditure on food but not expenditure on education or health. Thus creating a discrepancy.

Another problem is using a single index for the whole nation. Because of poor supply chain system and due to lack of common national market for agricultural products; food products prices differ with huge margins across cities. Also, weights are different for rural & urban. Rural food category has a weight of 54.18% whereas urban has a weight of 36.29%. Thus according to these weights, 1 % increase in food prices at both rural and urban level will impact a rural person relatively 18% higher than at the urban person. This interpretation proves wrong if we talk about rural & urban daily wage laborers since both of them will be affected equally. Therefore, we cannot talk of food inflation with a single figure for two different regions. There are many issues like these which need to be taken care of, for a better understanding or discussion of inflation.

How to read inflation?

Its figures mostly used in an aggregate sense by economists & policy makers. Also, they make necessary corrections to these figures according to applications. But during discussions with the common public, Media and anyone who is discussing inflation had to be very specific to which category of inflation he/she is talking and who the affected ones are.

The whole point of discussion is Inflation is very wide & deep phenomenon. People should not frame their mind or attach emotions to these inflation indices without understanding them fully.

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