​●​ S ​ tagflation​​:​ ​High​ ​inflation​ ​and​ ​stagnant​ ​economic​ ​growth​ ​leads​ ​to​ ​stagflation.

Rise​​in​​prices​​while​
​unemployment is high.​
​●​ ​Headline​​inflation:​​Headline​​inflation​​is​​a​​measure​​of​​the​​total​​increase​​in​​the​​price​​level​​of​​a​​broad​
​basket of goods and services in an economy. It includes food and energy​
​●​ ​Core inflation​​: Core inflation excludes volatile items​​like food and energy.​
​●​ ​Monetary​ ​inflation​ ​refers​ ​to​ ​a​ ​sustained​ ​rise​ ​in​ ​the​ ​money​ ​supply​ ​in​ ​an​ ​economy,​ ​often​ ​due​ ​to​
​central​ ​bank​ ​policies​ ​like​ ​printing​ ​currency,​ ​lowering​ ​interest​ ​rates,​ ​or​ ​deficit​ ​financing,​ ​which​ ​can​
​drive up overall price levels if not matched by production growth.​
​●​ ​Structural​​inflation​​is​​persistent​​price​​rise​​caused​​by​​long-term​​imbalances​​in​​production,​​labor,​​or​

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​supply chains, often requiring supply-side reforms rather than monetary measures.​

​Measurement of Inflation​

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​Wholesale Price Index​
​●​ ​Measure​​of​​the​​average​​change​​of​​prices​​of​​a​​fixed​​set​​of​​goods​​at​​the​​first​​point​​of​​bulk​​sale​
​in a commercial transaction in the domestic market over a given period of time.​
​●​ ​Released​ ​by:​ ​Office​ ​of​ ​the​ ​Economic​ ​Adviser,​ ​Department​ ​for​ ​Promotion​ ​of​ ​Industry​ ​and​

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​Internal Trade.​
​●​ ​(Base Year: 2011-12)​
​●​ ​Measurement​​:​ ​Measured​ ​as​ ​a​ ​weighted​ ​average​ ​of​ ​a​ ​basket​ ​of​ ​commodities​​.​ ​It​ ​does​ ​not​
​cover services.​​[CSE 2020]​
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​●​ ​Composition of Basket:​​Comprises 697 items categorized​​into three major groups:​
​o Primary Articles (Weight: 22.618 out of 100)​
​o Fuel and Power (Lowest weight: 13.152 out of 100)​
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​o Manufactured Products (Highest weight: 64.230 out of 100)​
​Producer Price Index​
​●​ ​The​ ​Producer​ ​Price​ ​Index​ ​(PPI)​ ​measures​ ​the​ ​average​​change​​over​​time​​in​​the​​selling​​prices​​that​
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​domestic producers receive for their output.​

​●​ ​It​​tracks​​inflation​​at​​the​​wholesale​​level,​​reflecting​​price​​changes​​from​​the​​perspective​​of​​producers​
​rather than consumers.​
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​●​ ​The​ ​PPI​ ​covers​ ​prices​ ​of​ ​goods​ ​and​ ​services​ ​at​ ​the​ ​initial​ ​point​ ​of​ ​sale,​​including​​finished​​goods,​
​intermediate goods, and raw materials, excluding taxes, transport, and trade margins.​
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​Consumer Price Index:​

​●​ ​The​ ​CPI​ ​measures​ ​changes​ ​in​ ​the​ ​prices​ ​of​ ​a​ ​fixed​ ​basket​ ​of​ ​goods​ ​and​ ​services​ ​typically​
​purchased by a representative consumer.​
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​●​ ​It quantifies the inflation experienced by consumers.​

​●​ ​CPI is expressed as a percentage change in prices from a base year​
​●​ ​CPI = (Cost of Basket in Current Year / Cost of Basket in Base Year) * 100​
​●​ ​It reflects inflation at the retail level.​
​●​ ​It is used by the RBI as measure of inflation.[CSE 2020]​
​●​ ​Component​ ​of​ ​CPI-​​Food​ ​and​ ​Beverage​ ​45.86%,​ ​Housing​ ​10.07%,​ ​Clothing​ ​and​​Footwear​​6.53,​
​Fuel and Light 6.84%, Misc 30.70​​[CSE 2020]​

​CPI (Industrial Workers)​

​●​ ​Mainly​​used​​for​​determining​​Dearness​​Allowance​​(DA)​​paid​​to​​central/state​​government​​employees​
​and workers in the industrial sectors.​
​●​ ​Compiled​ ​and​ ​maintained​ ​by​ ​the​ ​Labour​ ​Bureau,​ ​an​ ​attached​ ​office​ ​of​ ​the​ ​Ministry​​of​​Labour​​&​
​Employment.​
​●​ ​Base Year​​: 2016.​

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​CPI (Urban Non-Manual Employees)​
​●​ ​This​​index​​depicts​​the​​changes​​in​​the​​level​​of​​average​​retail​​prices​​of​​goods​​and​​services​​consumed​
​by the urban segment of the population.​
​●​ ​It​ ​is​ ​used​ ​for​ ​determining​ ​Dearness​ ​Allowances​ ​(DAs)​ ​of​ ​employees​ ​of​ ​some​ ​foreign​ ​companies​
​operating​​in​​India​​(i.e.​​airlines,​​communications,​​banking,​​insurance,​​embassies,​​and​​other​​financial​
​services).​
​●​ ​Base Year​​: 1984-85.​
​Note: It is discontinued since January 2011 because of outdated base year and also CPI​
​(Urban) is brought out.​

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​CPI (Agricultural Labor)​
​●​ ​This index is used for revising minimum wages for agricultural labourers in different states.​
​●​ ​Compiled by the Labour​​Bureau in the Ministry of​​Labour and Employment.​

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​●​ ​Base Year​​: 1986-87.​

​CPI (Rural Worker)​

​●​ ​It​​is​​proposed​​for​​determining​​minimum​​wages​​for​​the​​government's​​rural​​jobs​​programme​​under​​the​

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​Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), though currently​
​CPI-AL is used for determining MGNREGA Wages.​
​●​ ​Compiled by the Labour​​Bureau in the Ministry of​​Labour and Employment.​
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​●​ ​Base Year​​: 1983.​

​Criteria​ ​WPI​ ​CPI​ ​GDP Deflator​

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​Definition​ ​ verage​​change​​in​​price​
A ​ hanges​ ​in​ ​the​ ​retail​
C ​ hanges​ ​in​ ​price​ ​of​ ​all​
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​of​​goods​​that​​are​​bought​ ​price​ ​of​​specified​​goods​ ​new,​ ​domestically​
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​and​ ​sold​ ​in​ ​the​ ​and​​services​​over​​a​​time​ ​produced​ ​final​ ​goods​

​wholesale market​ ​period.​ ​and​ ​services​ ​in​ ​an​
​economy.​
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​Base year​ ​2011-12​ ​2012​ ​2011-12​

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​Coverage​ ​Only goods​ ​Goods and Services​ ​Goods and Services​

​Released By​ ​ ffice​ ​of​

O ​Economic​ ​NSO​ ​NSO​
​Advisor​
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​Basket​ ​ ixed​​basket​​of​​goods​​in​ F
F ​ ixed​ ​basket​ ​of​ ​goods​ D
​ epends​ ​on​ ​the​
​3 categories.​ ​and​ ​services​ ​in​ ​5​ ​production of goods &​
​categories.​ ​Services​

​Key Terms Related to Inflation​

​●​ S ​ kewflation​​:​ ​When​ ​there​ ​is​ ​a​ ​price​ ​rise​ ​of​ ​one​​or​​a​​small​​group​​of​​commodities​​over​​a​​sustained​
​period of time, without a traditional designation.​
​●​ ​Deflation​​:​​It​​is​​a​​general​​decline​​in​​the​​overall​​price​​level​​of​​goods​​and​​services,​​usually​​measured​
​by CPI or WPI.​
​●​ ​Reflation​​:​ ​Reflation​ ​refers​ ​to​ ​decreases​ ​the​ ​rate​ ​of​ ​inflation.​ ​It​ ​is​ ​the​ ​deliberate​ ​policy​ ​action​ ​by​
​government​ ​or​ ​bank​ ​to​ ​revive​ ​demand​ ​and​ ​push​ ​prices​ ​up​ ​to​ ​normal​ ​levels​ ​during​ ​deflation​ ​or​
​slowdown (through fiscal/monetary stimulus)​
​●​ ​Philips​ ​curve:​ ​The​ ​Phillips​ ​Curve​ ​illustrates​ ​a​ ​short-run​ ​trade-off​ ​between​ ​inflation​ ​and​
​unemployment,​ ​showing​ ​that​ ​lower​ ​unemployment​ ​is​ ​associated​ ​with​ ​higher​ ​inflation,​ ​and​ ​vice​
​versa.​ ​This​ ​concept,​ ​named​​after​​economist​​A.W.​​Phillips,​​suggests​​policymakers​​face​​a​​dilemma:​
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 ​ timulating​ ​the​ ​economy​ ​to​​reduce​​unemployment​​may​​lead​​to​​rising​​prices,​​while​​fighting​​inflation​
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​might increase unemployment.​
​●​ ​Engel’s​ ​law:​ ​Engel's​ ​Law​ ​is​​an​​economic​​theory​
​put​ ​forth​ ​in​ ​1857​ ​by​ ​Ernst​ ​Engel,​ ​a​ ​German​
​statistician.​ ​It​ ​states​ ​that​ ​the​ ​percentage​ ​of​
​income​ ​allocated​ ​for​ ​food​ ​purchases​ ​decreases​
​as​ ​a​ ​household's​ ​income​ ​rises,​ ​while​ ​the​
​percentage​ ​spent​ ​on​ ​other​ ​things​ ​(such​ ​as​
​education and recreation) increases.​

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​●​ ​Inflationary​ ​gap:​ ​Difference​ ​between​ ​current​
​level​​of​​real​​GDP​​and​​potential​​GDP​​when​​GDP​​is​
​full​ ​[Link]​ ​is​ ​the​ ​excess​ ​of​ ​aggregate​
​demand​ ​(AD)​ ​over​ ​aggregate​ ​supply​ ​(AS)​ ​at​ ​full​

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​employment level of output.​
​●​ ​Deflationary​ ​Gap:​ ​The​ ​shortfall​ ​in​ ​total​ ​spending​ ​of​ ​the​ ​government​ ​(i.e.​ ​fiscal​ ​surplus)​ ​over​ ​the​
​national​​income​​creates​​deflationary​​gaps​​in​​the​​economy.​​This​​is​​a​​situation​​of​​producing​​more​​than​
​the demand and the economy usually heads for a general slowdown in the level of demand.​

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​●​ ​Inflation​ ​tax:​ ​Inflation​ ​erodes​ ​the​ ​value​ ​of​ ​money​ ​and​ ​people​ ​who​ ​hold​ ​currency​ ​suffer​ ​in​ ​this​
​process.​
​​
● ​Inflation Spiral:​​When wages press price up and prices pull wages up.​
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​●​ ​Inflation​ ​Accounting:​ ​Due​ ​to​ ​inflation​ ​the​ ​profit​ ​of​ ​firms/companies​ ​get​ ​overstated.​ ​When​ ​a​ ​firm​
​calculates​ ​its​ ​profits​ ​after​ ​adjusting​ ​the​ ​effect​ ​of​​current​​level​​of​​inflation,​​this​​process​​is​​known​​as​
​inflation accounting.​
​●​ ​Inflation​ ​Premium:​ ​The​ ​bonus​ ​brought​ ​by​ ​the​ ​inflation​ ​to​ ​the​ ​borrowers​​is​​known​​as​​the​​inflation​
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​premium.​
​●​ ​Price​ ​Wage​ ​Spiral-​​The​ ​Price-Wage​ ​Spiral​​is​​a​​phenomenon​​where​​rising​​wages​​and​​rising​​prices​
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​create a feedback loop, each one driving the other​​.​

​●​ ​Retail​ ​Inflation​​-​ ​It​ ​measures​ ​the​ ​rate​ ​at​ ​which​ ​the​ ​prices​ ​of​ ​goods​ ​and​ ​services​ ​purchased​ ​by​
​consumers increase or decrease over time. It is measured through the consumer price Index.​
​●​ ​Consumer​​FoodPrice​​Index​​(CFPI)​​Same​​as​​CPI​​for​​‘Food​​and​​Beverages’​​except​​that​​it​​does​​not​
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​include alcoholic beverages and Prepared meals, snacks, sweets, etc.​

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​●​ ​Price​​StabilizationFund​​(PSF​​)​​Set​​up​​in​​2014-15​​under​​Department​​of​​Agriculture,​​Cooperation​​&​
​Farmers​ ​Welfare​ ​to​ ​regulate​ ​price​ ​volatility​ ​of​ ​important​ ​agri-horticultural​ ​commodities​ ​like​ ​onion,​
​potatoes and pulse.​
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​Base Effect [CSE 2011]​

​ he​ ​base​ ​effect​ ​in​ ​inflation​ ​describes​ ​how​​the​​price​​level​​from​​a​​previous​​period​​affects​​the​​calculation​​of​
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​the​ ​current​​inflation​​rate.​​If​​prices​​were​​unusually​​low​​in​​the​​earlier​​period,​​even​​a​​moderate​​increase​​now​
​can result in a significantly higher inflation percentage—a phenomenon called the low base effect.​
​Working of Base Effect​
​●​ ​Low​ ​Base​ ​Effect:​ ​If​ ​prices​ ​were​ ​abnormally​ ​low​ ​in​ ​the​ ​previous​ ​period​ ​(a​ ​low​ ​base),​ ​the​ ​current​
​increase in prices will appear larger as a percentage, leading to a high inflation rate.​
​●​ ​High​ ​Base​​Effect:​​If​​prices​​were​​abnormally​​high​​in​​the​​previous​​period​​(a​​high​​base),​​the​​current​
​increase in prices will appear smaller as a percentage, leading to a low inflation rate.​
​Example​​:​
​●​ ​Scenario​​1:​​A​​price​​index​​of​​₹100​​in​​Year​​1​​increases​​to​​₹150​​in​​Year​​2.​​The​​inflation​​is​​50%​​(₹50​​/​
​₹100).​
​●​ ​Scenario​ ​2:​​The​​same​​absolute​​increase​​of​​₹50​​occurs​​in​​Year​​3,​​but​​the​​price​​index​​is​​now​​₹200.​
​The inflation rate is 33.3% (₹50 / ₹150), a lower percentage.​

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​Impact of the Base Effect:​
​●​ ​Misleading Perceptions​​: The base effect can distort​​how people perceive the true level of inflation.​
​●​ ​Economic​ ​Analysis:​ ​Understanding​ ​it​ ​is​ ​crucial​ ​for​ ​economists​ ​and​ ​policymakers​ ​to​ ​interpret​
​economic data accurately and to avoid making decisions based on misleading inflation figures.​
​●​ ​Market​ ​Reactions​​:​ ​It​ ​can​ ​lead​ ​to​ ​emotional​ ​or​ ​impulsive​ ​trading​ ​decisions​ ​if​ ​traders​ ​react​ ​to​
​dramatic percentage changes without considering the underlying price levels.​

​Impact of Inflation​
​Positive Impact​

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​1.​ ​Encourages​ ​Spending:​ ​Inflation​ ​motivates​ ​consumers​ ​to​ ​spend​ ​money​ ​sooner​ ​rather​ ​than​ ​later​
​because prices tend to rise over time, which boosts overall demand in the economy.​
​2.​ ​Reduces​ ​Real​​Debt​​Burden:​​Inflation​​lowers​​the​​real​​value​​of​​outstanding​​debts,​​making​​it​​easier​

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​for​ ​borrowers​ ​to​ ​repay​ ​loans​ ​with​ ​"cheaper"​ ​money​ ​over​ ​[Link]​ ​benefits​ ​the​ ​debtor.​ ​[CSE​
​2013​​]​
​3.​ ​Facilitates​ ​Wage​ ​and​ ​Price​​Adjustments:​​Moderate​​inflation​​allows​​easier​​adjustment​​of​​relative​
​wages and prices without the need for nominal wage cuts, which are often resisted.​

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​4.​ ​Boosts​​Economic​​Growth:​​Moderate​​inflation​​can​​stimulate​​production​​and​​investment,​​leading​​to​
​job creation and improved economic growth.​
​5.​ ​Prevents​​Deflation​​:​​Inflation​​protects​​against​​deflation,​​which​​can​​be​​more​​harmful​​by​​encouraging​
​delayed spending and increasing the real burden of debt.​
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​Negative Impact​
​1.​ ​Erodes​​Purchasing​​Power:​​Inflation​​reduces​​the​​value​​of​​money,​​causing​​consumers​​to​​buy​​fewer​
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​goods and services with the same amount of money.​
​2.​ ​Disproportionate​​Impact​​on​​Low-Income​​Groups:​​Inflation​​hits​​lower-income​​households​​harder,​
​as​ ​they​ ​spend​ ​a​ ​larger​ ​share​ ​of​ ​their​ ​income​ ​on​ ​essentials​ ​like​ ​food​ ​and​ ​energy,​ ​which​ ​often​
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​experience higher price increases.​

​3.​ ​Higher​​Interest​​Rates:​​Inflation​​leads​​to​​higher​​interest​​rates​​over​​time,​​increasing​​borrowing​​costs​
​for businesses and individuals, which can reduce investments and slow economic growth.​
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​4.​ ​Reduces​ ​Savings:​​Inflation​​diminishes​​the​​real​​value​​of​​savings,​​discouraging​​people​​from​​saving​

​and potentially limiting funds available for investment.​
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​General Impact of Inflation​

​●​ O ​ n​​creditor​​and​​debtor​​-​​Creditors​​lose​​out​​during​​inflation​​because​​the​​value​​of​​money​​decreases,​
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​while​ ​debtors​ ​benefit​ ​as​ ​they​ ​repay​ ​their​ ​loans​​with​​money​​that​​has​​less​​purchasing​​power​​than​​it​

​did when they borrowed.​
​●​ ​On​ ​exchange​ ​rate​ ​-​ ​Generally​ ​inflation​ ​leads​ ​to​ ​depreciation​ ​of​ ​currency​ ​because​ ​the​ ​value​ ​of​
​money in foreign currency terms reduces.​
​●​ ​On​​Export​​and​​import​​-​​Export​​becomes​​cheap​​and​​import​​becomes​​dearer​​due​​to​​depreciation​​of​
​currency occurred because of inflation.​
​●​ ​On purchasing power​​- Purchasing power of money is​​reduced due to inflation.​
​●​ ​On​ ​The​ ​Rate​ ​of​ ​Interest​ ​-​ ​It​ ​rises​ ​because​ ​banks​ ​are​ ​getting​ ​less​ ​deposits​ ​leading​ ​to​ ​reduced​
​availability​ ​of​ ​money​ ​with​ ​banks​ ​and​ ​hence​ ​the​ ​raise​ ​interest​ ​to​ ​balance​ ​demand​ ​and​ ​supply​ ​of​
​credit.​
​●​ ​On​​Bond​​price​​-When​​inflation​​rises,​​the​​prices​​of​​existing​​bonds​​in​​the​​market​​generally​​decrease.​
​This​​is​​because​​inflation​​erodes​​the​​purchasing​​power​​of​​the​​fixed​​coupon​​payments​​received​​from​
​bonds.​​Investors​​are​​willing​​to​​pay​​less​​for​​a​​bond​​that​​offers​​fixed​​coupon​​payments​​that​​will​​have​
​reduced real value in the future.​

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 ​●​ O ​ n​ ​Bond​ ​yield​ ​-​ ​As​ ​inflation​ ​increases,​ ​bond​​yields​​tend​​to​​rise.​​Bond​​yields​​represent​​the​​return​
​that​ ​investors​ ​receive​ ​relative​ ​to​ ​the​ ​price​ ​they​​pay​​for​​the​​bond.​​When​​inflation​​expectations​​rise,​
​bondholders​ ​demand​ ​higher​ ​yields​ ​to​ ​compensate​ ​for​ ​the​ ​decreased​ ​purchasing​ ​power​ ​of​ ​the​
​bond’s fixed coupon payments​​.​
​●​ ​On​​The​​Level​​of​​Aggregate​​Demand​​And​​Supply​ ​-​​As​​inflation​​[cost​​push]​​rises,​​the​​cost​​of​​raw​
​materials​ ​increases,​ ​leading​ ​to​ ​a​ ​decline​ ​in​ ​aggregate​ ​supply.​ ​Over​ ​time,​ ​with​ ​persistent​ ​inflation​
​eroding​ ​the​ ​purchasing​ ​power​ ​of​ ​money,​ ​consumers'​ ​ability​ ​to​ ​spend​ ​diminishes,​ ​resulting​ ​in​ ​a​
​reduction in aggregate demand in the medium and long term​

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​Mechanism to control inflation in India​
​●​ I​nflation​ ​in​ ​India​ ​is​ ​primarily​ ​managed​ ​by​ ​the​​Reserve​​Bank​​of​​India​​(RBI)​​and​​the​​Government​​of​
​India through a​​combination of monetary and fiscal​​policies.​

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​●​ ​The​ ​Monetary​ ​Policy​ ​Framework​ ​Agreement​​(MPFA)​​between​​the​​Government​​of​​India​​and​​the​
​RBI aims to maintain price stability while considering growth.​
​●​ ​According​ ​to​ ​this​ ​agreement,​ ​if​ ​inflation​ ​stays​ ​outside​ ​the​ ​2%​ ​to​ ​6%​ ​range​ ​for​ ​three​ ​consecutive​
​quarters,​ ​the​ ​RBI​ ​must​ ​report​ ​to​ ​the​ ​central​ ​government,​ ​explaining​ ​the​ ​reasons,proposing​

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​corrective actions, and estimating when inflation will return to the target range.​
​RBI (Monetary Policy)​
​●​ ​Inflation Targeting​​: The RBI aims to maintain inflation​​within a target range of 4% ± 2%.​
​●​ ​Interest​ ​Rate​ ​Adjustments​​:​ ​The​ ​RBI​​uses​​repo​​rates,​​Standing​​Deposit​​Facility(SDF)and​​reverse​
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​repo rates to control inflation by managing demand and liquidity.​​[CSE 2023]​
​●​ ​Open Market Operations​​: It buys and sells government​​securities to control money​
​supply.​
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​Government (Fiscal Policy)​
​●​ ​Expenditure Control:​​The government regulates public​​spending to avoid inflationary pressure.​
​●​ ​Subsidies​​: It provides subsidies to control prices​​of essential goods like food and fuel.​
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​It​ ​Subsidies​ ​may​ ​temporarily​ ​reduce​ ​prices,​ ​but​ ​can​ ​worsen​ ​fiscal​ ​deficit,​ ​which​ ​itself​ ​can​ ​fuel​
​long-run inflation​
​●​ ​fuel.​
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​Supply-Side Measures:​
​●​ ​Agricultural Policies: Boosting agricultural output to manage food inflation.​
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​●​ ​Infrastructure Development: Reducing supply chain bottlenecks.​

​External Factors:​
​●​ ​Exchange​​Rate​​Management:​​The​​RBI​​stabilizes​​the​​rupee​​to​​control​​import​​[Link]​​follows​​a​
​managed​​float​​exchange​​rate​​system.​​RBI​​intervenes​​only​​to​​reduce​​volatility,​​not​​to​​fix​​or​​“stabilise”​
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​rupee at a specific level.​

​●​ ​Tariffs and Taxes:​​The government adjusts duties to​​manage the cost of imports.​

​Business Cycle​
​ he​ ​business​ ​cycle​ ​describes​​the​​rise​​and​​fall​​in​​production​​output​​of​​goods​​and​​services​​in​​an​​economy.​
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​Business​​cycles​​are​​generally​​measured​​using​​the​​rise​​and​​fall​​in​
​real gross domestic product (GDP) or GDP adjusted for inflation.​

​Four Stage of Business Cycle​

​1.​ ​Depression​ ​-​ ​A​ ​depression​ ​is​ ​a​ ​severe​ ​and​ ​prolonged​
​downturn​ ​in​ ​economic​ ​activity.​ ​It​ ​is​ ​an​ ​extreme​ ​recession​
​that​​lasts​​three​​or​​more​​years​​or​​leads​​to​​a​​decline​​in​​real​
​gross​ ​domestic​ ​product​ ​(GDP)​ ​of​ ​at​ ​least​ ​10​ ​percent.​
​Example:-The Great Depression of 1930​
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