The newscard discusses inflation trends and factors that affect it. Important from both Pre and Mains point of view. Bookmark it.
From UPSC perspective, following things are important:
Prelims level: CPI, its base year, NSSO, Engel’s law, Base effect, Blue moon concept (geography).
Mains level: Despite a decline in inflation numbers, inflation is visible commonly, why?
- India’s latest retail inflation numbers show that the inflation rate, measured by the Consumer Price Index (Combined — new series) was 2.2% for May 2017
- A CPI inflation rate below 2.5% is a once-in-a-blue-moon occurrence in India
- Earlier this index was CPI – Industrial Workers
Three reasons why lowering of inflation does not reflect in common prices:
a) Place to place difference: All-India CPI Combined is compiled by collecting town and village-level data on the prices of goods and services across States and then aggregating them
- All States and Union Territories do not get equal weighting in the total
- The weights are decided by the consumption expenditure within each State relative to the all-India consumption basket
- While the State of Maharashtra gets a 13.2% weight in the all-India CPI (Combined), J&K weighs in with just 0.94%, Puducherry with 0.17% and Sikkim with 0.05% (Seeing Prelims 2017, you may be asked numbers next year 🙁 )
- Runaway inflation in India’s less populous low-spend States and Union Territories is unlikely to show up in the form of a big swing in the overall index
b) Consumption basket: In order to arrive at a CPI General Index that is representative of both India and Bharat, the statistics office assigns different weights to the different products and services
- These weights are derived from the actual spending patterns of rural and urban households as captured by the NSSO’s ground-level survey of expenditure patterns across India
- The latest such survey was the 68th round conducted over 2011-12
- Because the majority of Indian households belong to lower-income strata, the CPI General Index thus carries a far higher weight to products than services
- Services often witness higher price rise than products in the Indian context
- In practise, more affluent households will tend to spend a far lower proportion of their income on food and essentials and make a higher allocation to non-essentials and services (This is known as Engel’s Law)
c) Base effect: The official CPI print captures the point-to-point change in the index in the latest month, compared to the same month last year
- This makes the number susceptible to distortions from one-off factors both in the base month and in the current one
- Every year, food prices usually soar in the months of April-May as they represent the pre-monsoon months when food crops are in short supply
- This year a bountiful monsoon has led to a bumper production of pulses, oilseeds and horticultural crops and thus lowering of prices
- If we ignore the monthly numbers and focus on three-year trends instead, we find that price levels have continued to creep up steadily. Between May 2014 and now, the CPI Combined has risen at an annual 4.5%.
Suppose if the base year the consumer price index is 100, next year it goes to 150 and the next to 200. Now the last years inflation is 33.5% where as actually it is (200–100)/100)100=100%.
So if in a country there is cost of living allowance on salary, in place of a 100% rise in wages one will get only 33.5% rise in wages which is too low for the reality of the economic state.
This is called the base effect, which tend to understate the inflation numbers when inflation is rising and overstate when prices are falling.