INFLATION

INFLATION: BASICS

Definition: a rise in the general level of prices of goods and services.
Effect: purchasing power of money decreases.
Debtor vs lender: the debtor/borrower benefits more than the lender, because the money repaid has less purchasing power than the money borrowed.

Real Interest Rate = Nominal Interest Rate − Inflation

Types of Inflation (by rate)

Type	Rate
Creeping	3–4%
Walking	4–10%
Running	10–20%
Galloping	20–100%
Hyperinflation	Above 100%

Inflationary gap: demand exceeds supply; actual GDP exceeds potential GDP.

Seigniorage

Profit earned by the central bank from issuing currency.
Seigniorage = Face value − Production cost

CAUSES OF INFLATION

Basis	Demand-Pull Inflation	Cost-Push Inflation
Cause	Increase in demand (demand side).	Increase in production costs (supply side).
Examples	Strong economic growth, higher government spending, increased exports.	Higher wages, raw material prices, indirect taxes; rise in cost of any factor of production.
Duration	Can be short-term.	Can be long-term.

MEASUREMENT OF INFLATION

Inflation is measured using the Wholesale Price Index (WPI) and the Consumer Price Index (CPI).

Inflation Rate = [(Current Year Index − Previous Year Index) ÷ Previous Year Index] × 100

Feature	WPI	CPI
Measures	Average change in prices at the wholesale level, before goods reach consumers.	Average change in prices at the consumer/retail level; reflects cost of living.
Published by	Office of Economic Adviser (OEA), Ministry of Commerce and Industry.	National Statistical Office (NSO), MoSPI.
Base year	2022–23 (earlier 2011–12).	2024 (CPI Combined).
Frequency	Monthly, on the 14th.	Monthly, usually on the 12th.
Weightage	Manufactured goods: 64.2% Primary articles: 22.6% Fuel and power: 13.15%	Food and beverages: 45.8% (highest) Housing: 10% Fuel and power: 6.8%
Formula	WPI = 100 × (cost of fixed basket in current year ÷ cost in base year).	CPI = 100 × (cost of fixed basket in current year ÷ cost in base year).

Four Types of CPI

CPI Type	Base Year	Released by
CPI – Industrial Workers (IW)	2016	Labour Bureau
CPI – Agricultural Labourers (AL)	2019	Labour Bureau
CPI – Rural Labourers (RL)	2019	Labour Bureau
CPI – Rural / Urban / Combined	2024	NSO, MoSPI

CPI Combined is used by the RBI for inflation targeting and formulating monetary policy.

Producer Price Index (PPI)

Measures the average change in selling prices received by domestic producers for their output. Perspective: seller’s (unlike CPI, which is the buyer’s).
Significance: captures price changes at the “factory gate”, before taxes and distribution costs.

Core Inflation

Inflation excluding food and energy prices; calculated using CPI.
Core Inflation = Headline Inflation − Volatile Inflation

Index of Industrial Production (IIP)

Base year: 2022–23. Published by: NSO, MoSPI.
Eight core industries contribute about 40% of IIP. In decreasing order of weight: Refinery Products → Electricity → Steel → Coal → Crude Oil → Natural Gas → Cement → Fertilizers.

Monetary Policy Framework Agreement (MPFA)

Signed between the Government of India and the RBI in February 2015.
Mandates the RBI to maintain price stability while keeping growth in mind, with a target of CPI inflation at 4% ± 2%.

DYNAMICS OF INFLATION

Term	Key Points
Disinflation	Fall in the rate of inflation while prices may still be rising (e.g., 10% → 8% → 7% → 5%). Cause: slowdown in money supply through tighter monetary policy.
Deflation	General fall in prices of goods and services; purchasing power increases. Causes: reduced money supply, reduced investment, lower production.
Stagflation	High inflation with low economic growth (stagnation + inflation); high unemployment results. Cause: production of goods and services slows or declines.
Shrinkflation	Price stays the same but product size or quantity is reduced, effectively raising the price per unit.
Bottleneck Inflation	Supply restricted at one stage of production or distribution, causing shortages and a price rise.
Skewflation	Prices of essential goods (especially food) rise sharply while non-essentials stay stable or rise slowly.
Reflation	Deliberate government policy to raise economic activity and prices (more money supply, spending, or lower taxes), usually to recover from recession.
Imported Inflation	Rise in domestic price level due to higher prices of imported goods and raw materials.
Inflationary Gap	Excess of aggregate demand over aggregate supply at full employment, putting upward pressure on prices.

Phillips Curve

Graph showing the relationship between unemployment and inflation.
The two have an inverse relationship: high inflation goes with low unemployment, and low inflation with high unemployment.

PYQS

Q1. Which index is used by the Reserve Bank of India (RBI) as the primary anchor for monetary policy to measure inflation in India? (SSC CGL Tier-1)

(A) Wholesale Price Index (WPI)

(B) Consumer Price Index (Combined) (CPI-C)

(D) Index of Industrial Production (IIP)

Answer: (B) Consumer Price Index (Combined) (CPI-C)

Q2. What is “Core Inflation” derived from? (SSC CHSL Tier-1)

(A) Headline inflation minus manufacturing goods

(B) Headline inflation plus volatile energy prices

(D) Whole price index minus services

Answer: (C) Headline inflation minus volatile items like food and fuel

Q3. A situation characterized by slow economic growth, high unemployment, and high inflation occurring simultaneously is known as: (SSC MTS / GD CBT)

(A) Hyperinflation

(B) Stagflation

(D) Disinflation

Answer: (B) Stagflation

Q4. What is the primary difference between the Wholesale Price Index (WPI) and the Consumer Price Index (CPI) in India? (SSC CPO Tier-1)

(A) CPI includes services, whereas WPI does not include services

(B) WPI is published by NSO, while CPI is published by DPIIT

(D) CPI excludes food items entirely

Answer: (A) CPI includes services, whereas WPI does not include services

Q5. “Too much money chasing too few goods” describes which form of inflation? (SSC GD CBT)

(A) Cost-push inflation

(B) Demand-pull inflation

(D) Structural inflation

Answer: (B) Demand-pull inflation