What is Inflation?

What is the meaning of Inflation ?

In economics inflation means, a rise in general level of prices of goods and services in a economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Thus, inflation results in loss of value of money. Another popular way of looking at inflation is "toomuch money chasing too few goods". The last definition attributes the cause of inflation to monetary growth relative to the output / availability of goods and services in the economy.

In case the price of say only one commodity rise sharply but prices of other commodities fall, it will not be termed as inflation. Similarly, in case due to rumors if the price of a commodity rise during the day itself, it will not be termed as inflation. 


The Link Between Inflation and Money

Because inflation is a rise in the general level of prices, it is intrinsically linked to money, as captured by the often heard refrain "Inflation is too many dollars chasing too few goods". To understand how this works, imagine a world that only has two commodities: Oranges picked from orange trees, and paper money printed by the government. In a year where there is a drought and oranges are scarce, we'd expect to see the price of oranges rise, as there will be quite a few dollars chasing very few oranges. Conversely, if there's a record crop or oranges, we'd expect to see the price of oranges fall, as orange sellers will need to reduce their prices in order to clear their inventory. These scenarios are inflation and deflation, respectively, though in the real world inflation and deflation are changes in the average price of all goods and services, not just one.


What are different types of inflation ?

Broadly speaking inflation is divided into two categories i.e.

(a) DEMAND - PULL INFLATION: In this type of inflation prices increase results from an excess of demand over supply for the economy as a whole. Demand inflation occurs when supply cannot expand any more to meet demand; that is, when critical production factors are being fully utilized, also called Demand inflation.


(b) COST - PUSH INFLATION: This type of inflation occurs when general price levels rise owing to rising input costs. In general, there are three factors that could contribute to Cost-Push inflation: rising wages, increases in corporate taxes, and imported inflation. [imported raw or partly-finished goods may become expensive due to rise in international costs or as a result of depreciation of local currency ]


What is Deflation ? :

Deflation is the opposite of inflation. Deflation refers to situation, where there is decline in general price levels. Thus, deflation occurs when the inflation rate falls below 0% (or it is negative inflation rate). Deflation increases the real value of money and allows one to buy more goods with the same amount of money over time. Deflation can occur owing to reduction in the supply of money or credit. Deflation can also occur due to direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. 



What is Stagflation ? 

Stagflation refers to economic condition where economic growth is very slow or stagnant and prices are rising. The term stagflation was coined by British politician Iain Macleod, who used the phrase in his speech to parliament in 1965, when he said: “We now have the worst of both worlds - not just inflation on the one side or stagnation on the other. We have a sort of ‘stagflation’ situation.” The side effects of stagflation are increase in unemployment- accompanied by a rise in prices, or inflation. Stagflation occurs when the economy isn't growing but prices are going up. At international level, this happened during mid 1970s, when world oil prices rose dramatically, fuelling sharp inflation in developed countries.



What is Hyperinflation ? 

Hyperinflation is a situation where the price increases are too sharp. Hyperinflation often occurs when there is a large increase in the money supply, which is not supported by growth in Gross Domestic Product (GDP). Such a situation results in an imbalance in the supply and demand for the money. In this this remains unchecked; it results into sharp increase in prices and depreciation of the domestic currency.


What is Headline Inflation ?

Headline inflation refers to inflation figure which is not adjusted for seasonality or for the often volatile elements of food & energy prices, which are removed in the Core CPI. Headline inflation will usually be quoted on an annualized basis, meaning that a monthly headline figure of 4% inflation equates to a monthly rate that, if repeated for 12 months, would create 4% inflation for the year. Comparisons of headline inflation are typically made on a year-over-year basis. Also known as "top-line inflation".



How Inflation is Measured in India?

Inflation is usually measured based on certain indices. Broadly, there are two categories of indices for measuring inflation i.e. Wholesale Prices and Consumer Prices.  


What is an Index Number ? 

An Index number is a single figure that shows how the whole set of related variables has changed over time or from one place to another. In particular, a price index reflects the overall change in a set of prices paid by a consumer or a producer, and is conventionally known as a Cost-of-Living index or Producer's Price Index as the case may be.


Wholesale Price Index (WPI) :

This index is the most widely used inflation indicator in India. This is published by the Office of Economic Adviser, Ministry of Commerce and Industry. WPI captures price movements in a most comprehensive way. It is widely used by Government, banks, industry and business circles. Important monetary and fiscal policy changes are linked to WPI movements. It is in use since 1939 and is being published since 1947 regularly. We are well aware that with the changing times, the economies too undergo structural changes. Thus, there is a need for revisiting such indices from time to time and new set of articles / commodities are required to be included based on current economic scenarios. Thus, since 1939, the base year of WPI has been revised on number of occasions. The current series of Wholesale Price Index has 2004-05 as the base year. Latest revision of WPI has been done by shifting base year from 1993-94 to 2004-05 on the recommendations of the Working Group set upwith Prof Abhijit Sen,, Member, Planning Commission as Chairman for revision of WPI series. This new series with base year 2004-05 has been launched on 14th September, 2010.  


Earlier, the concept of wholesale price covered the general idea of capturing all transactions carried out in the domestic market. The weights of the WPI did not correspond to contribution of the goods concerned either to value - added or final use. In order to give this idea a more precise definition, it was decided to define the universe of the wholesale price index as comprising as far as possible all transactions at first point of bulk sale in the domestic market.