Inflationary Trends- UPSC Current Affairs

Why in the News?

Recently, released official data revealed that the general price level Indian consumers faced was almost 8% higher in April 2022 than it was in the same month in 2021.

Probable Question

Discuss the factors responsible for the inflationary trends in the economy. Suggest some mitigation measures to check the skyrocketing prices.

Image Source: The Hindu

Key Points

About Inflation

• Inflation refers to the rise in the prices of most goods and services of daily or common use, such as food, clothing, housing, recreation, transport, consumer staples, etc. 
• It measures the average price change in a basket of commodities and services over time.
• Inflation is indicative of the decrease in the purchasing power of a unit of a country’s currency.
• A certain level of inflation is required in the economy to ensure that expenditure is promoted and hoarding money through savings is demotivated.
• The Ministry of Statistics and Programme Implementation measures inflation.
•  It is often referred to as a ‘tax on the poor’ as the low-income stratum of society bears the brunt.

What is the Base Effect?

• Base effect refers to the impact of an increase in the price level (i.e., previous year's inflation) over the corresponding rise in price levels in the current year (i.e., current inflation). 
• If the inflation rate was low in the corresponding period of the last year, then even a small increase in the price index will give a high rate of inflation in the current year. 
• Similarly, if there is a rise in the price index in the corresponding period of last year and recorded high inflation, then an absolute increase in the price index will show a lower inflation rate in the present year. 

How is Inflation measured?

• In India, inflation is primarily measured by two main indices — WPI (Wholesale Price Index) and CPI (Consumer Price Index), which measure wholesale and retail-level price changes, respectively. 
• The CPI calculates the difference in the price of commodities and services such as food, medical care, education, electronics etc, which Indian consumers buy for use.
• On the other hand, the goods or services sold by businesses to smaller businesses for selling further are captured by the WPI.

Major Causes of Inflation

• Demand-Pull inflation: Demand-pull inflation happens when the demand for certain goods and services is greater than the economy's ability to meet those demands. 
  • When this demand outpaces supply, there's an upward pressure on prices — causing inflation.
• Cost-Push inflation: Cost-push inflation is the increase of prices when the cost of wages and materials goes up. 
  • These costs are often passed down to consumers in the form of higher prices for those goods and services. 
• Increased Money Supply: If the money supply increases faster than the rate of production, this could result in inflation, particularly demand-pull inflation because there will be too much rupees chasing too few products.
• Devaluation: The Devaluation of a currency makes a country's exports less expensive, encouraging foreign nations to buy more of the devalued goods. 
  • Devaluation also makes foreign products for the devaluing country more expensive which encourages citizens of the devaluing country to buy domestic products over foreign imports.
• Policies and regulations: Certain policies can also result in either a cost-push or demand-pull inflation. 
  • For Example, When the government issues tax subsidies for certain products, it can increase demand. If that demand is higher than supply, costs could rise.

Why is faster inflation a concern for policymakers?

•  Persistent High inflation pushes several items out of reach for this category of consumers. 
  • For example, Onions and potatoes are generally a key staple in an average Indian family’s diet. But, if the price of potatoes starts rising rapidly, a poor household is often forced to sharply reduce or forgo its consumption of this key source of essential nutrients, including carbohydrates. 
• Over time, if unchecked, persistent high inflation erodes the value of money and hurts several other segments of the population, including the elderly living off a fixed pension.
• It hence ends up undermining a society’s consumptive capacity, and thereby, economic growth itself.

Effects of High Inflation

• High inflation rates will also worsen the exchange rate. High inflation means the rupee loses its power and, if the RBI doesn’t raise interest rates fast enough, investors will increasingly stay away because of reduced returns,
• It harms savers and helps borrowers.
• Rise in inflation will also lead to rise in bond yields, making government borrowing costlier.
• It helps the government meet debt obligations. In the short term the government which is the single largest borrower in the economy benefits from high inflation. Inflation also helps the government to meet its fiscal deficit targets.
• It reduces overall demand. The eventual fallout of reduced purchasing power is that consumers demand fewer goods and services.
• Mixed Results for Corporate Profitability: In the short term, corporations, especially the large and dominant ones, could enjoy higher profitability because they might be in a position to pass on the prices to consumers. 
  • But for many companies, especially smaller ones, persistently higher inflation will reduce sales and profitability because of lower demand.

Also watch a video on UPSC Daily Quiz on Trending Topics - May 17 and enhance your IAS Preparation :

Role of RBI in Tackling Inflation:

• In 2016, the Reserve Bank of India Act, 1934, was amended to provide a statutory basis for the implementation of a flexible inflation-targeting framework, where the Centre and the RBI would review and agree upon a specific inflation target every five years. 
• Under this, 4% was set as the Consumer Price Index (CPI) inflation target for the period from August 5, 2016, to March 31, 2021, with the upper tolerance limit of 6% and the lower tolerance limit of 2%.
• The Reserve Bank of India controls inflation through monetary policies which it does by increasing bank rates, repo rates, cash reserve ratio, buying dollars, regulating money supply and availability of credit. 
• These measures reduce the money supply in the market thus reducing demand which further decreases the prices.

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