Inflation

Inflation or price rise affects the common man directly and has devastating effect on any country’s economy. Inflation has spiraling effect and if not checked at the right time it would slow down the economic growth of any country.

Inflation is measured by monitoring the price index; the price index consists of thousands of products and services. Some of the key components of price index are:

Cereals, vegetables, pulses, meals, milk, milk products, oil, housing, fuel and light, education, transport and communications, medical care, personal care, recreation and amusement etc.

In every country the government keeps a close watch on inflation along with the central bank. Measures are taken to bring down the inflation to a certain tolerant limit so that the common man does not suffer.

Inflation is determined by calculating the rate of change in the price index. There are different ways to measure inflation. CPI (Consumer Price index) and WPI (Wholesale price index) are the two methods widely used to measure inflation. WPI was used previously but was later replaced by CPI by many developed nations to measure inflation. However there are few countries like India which still uses WPI to measure inflation.

Retail Price Index (used in UK), Cost of living indices, Producer price indices (similar to WPI), commodity price indices, GDP deflator, Capital goods price indices are few different ways by which inflation can be measured.

The three different types of inflation were described by Robert J. Gordon in his triangle model:

Cost-push inflation: Occurs when there is supply side constraint. Supply side constraint may occur due to several reasons like low production, increase in input costs, international conflicts etc. Generally there is little a government can do to increase the supply.

Demand-pull inflation: Occurs when the demand increases significantly. The increase in demand is attributed to the fact that there is excess liquidity in the market and people have high purchasing power.

Built in inflation: Most of the time employees force the employers to increase their wages. Due to increase in the wages the cost of production increases. In order to minimize loss the manufacturer passes on the cost to the consumers resulting in increase in the prices. This further leads to demand for more wage hike. Thus the increase in wage is linked to increase in price and vice versa. It results in vicious cycle and the government faces lots of difficulty in getting out of it.

In India WPI is used to measure inflation and not the CPI. Four different types of CPI which are applicable in India are:

· CPI-UNME: Consumer price index for urban non-manual employees.
· CPI-IW: Consumer price index for industrial workers.
· CPI-AL: Consumer price index for agricultural laborers.
· CPI-RL: Consumer price index for rural laborers.

Inflation is not just an economic phenomenon but it is also political in nature. Inflation has the potential to bring down governments. This is why the government proactively takes measures to cool down the prices.