Inflation is defined as an increase in the price of most everyday or common goods and services, such as food, clothing, housing, recreation, transportation, consumer staples, and so on. Inflation is defined as the average change in the price of a basket of goods and services over time. Deflation is the opposite and uncommon reduction in the price index of this bundle of items. Inflation is defined as a drop in the purchasing power of a country's currency unit. This is expressed as a percentage. In this article, we will see what is inflation, different ways to measure inflation and how inflation is measured in India.

What is inflation?

• Inflation is the rate at which the price of goods and services in a given economy rises.
• Inflation occurs when prices rise as manufacturing expenses, such as raw materials and wages, rise.
• Inflation can result from an increase in demand for products and services, as people are ready to pay more for them.
• Let us consider we can buy 1 litre of milk for Rs. 50 at the current time. Exactly 1 year before 1 litre of milk cost us Rs. 40.
• Here there is an increase of Rs. 10 per litre of milk or the purchasing power of Rs.40 has reduced from buying 1 litre of milk to 800ml of milk in 1 year.

• Therefore we can say that there is an inflation of 25% in milk prices compared to last year.

Different ways to measure inflation

Consumer Price Index

• Consumers frequently purchase directly from retailers. As a result, the inflation experienced in retail stores is a true reflection of the country's price rise. It also depicts the cost of living more accurately.
• The Consumer Price Index (CPI) is the name given in India to the index that shows the rate of inflation at the retail level. The CPI basket comprises 448 items in rural and 460 items in urban.
• There were four Consumer Price Indices in the economy, each covering a different socioeconomic group. Consumer Price Index for Industrial Workers (CPI-IW), Consumer Price Index for Agricultural Laborers (CPI-AL), Consumer Price Index for Rural Laborers (CPI-RL), and Consumer Price Index for Urban Non-Manual Employees were the four indices (CPI-UNME).
• CPI is now using a new series based on the base year 2012=100 for all of India as well as States/UTs separately for rural, urban, and combined. Consumer Price Indices are published by the Central Statistics Office (CSO), Ministry of Statistics and Program Implementation.
• The Consumer Price Index (CPI) is based on retail prices and is used to calculate the Dearness Allowance (DA) for government employees.

Note: CSO is merged into National Statistical Office (NSO) post-2019.

Wholesale Price Index

• In India, this was the most widely used method for calculating the inflation rate. The Wholesale Price Index (WPI) is the index used to calculate wholesale inflation.
• This rate of inflation is commonly referred to as headline inflation. The Office of Economic Advisor, Ministry of Commerce and Industry publishes the WPI. The base year is aligned with CPI as 2012=100.
• Prior to 2014, the RBI used WPI to make the majority of its policy decisions. However, the WPI-based inflation calculation was not false proof. WPI displays the total price of a commodity basket of 697 items.
• However, WPI excludes services and does not account for bottlenecks between producers and wholesalers or between wholesalers and retailers (consumer).
• As a result, as part of the reforms initiated by RBI governor Raghu Ram Rajan, the RBI shifted to CPI for policy decisions beginning in 2014.

Producers Price Index

• To begin, Producers Price Index (PPI) estimates the change in average prices received by producers, whereas CPI measures the change in average prices paid by consumers.
• The prices received by producers differ from the prices paid by consumers due to a variety of factors such as taxes, trade and transport margins, distribution costs, and so on.
• The PPI is derived from the Supply Use Table.
• The PPI estimates are used as deflators and for contract indexation, among other things.
• There is currently no index in India that measures inflation at the producer level. Although a Producer Price Index (PPI) is proposed, this type of inflation calculation has yet to begin in India.
• The new changes to WPI and excluding taxes while calculating WPI is bringing it closer to PPI indication.

Measuring Inflation in India

• Till 2014 India was using the Wholesale Price Index (WPI) to calculate the inflation rate in the economy.
• However, in 2014 as part of the reforms initiated by RBI governor Raghu Ram Rajan, the RBI shifted to CPI for better transmission of policy decisions.
• Since WPI had excluded services and had nearly a quarter of weightage assigned to fuel and metals it was decided to switch to CPI which included services like education, healthcare and reflect the true inflation at the consumer level.

Conclusion

Inflation that is unchecked has the potential to destroy the entire economy. As a result, a precise measurement of inflation is required to make policy decisions that keep inflation rates under control. Both the government and the central bank (Reserve Bank) use fiscal and monetary policies, which are referred to as Fiscal and Monetary Policies, respectively, to combat inflation. A more accurate picture of inflation aids policymaking.