inflation by shyam s kaggod...introduction “inflation is the persistent increase in the price...
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INFLATION
BY
SHYAM S KAGGOD
INTRODUCTION
“Inflation is the persistent increase in the price levels of
basket of commodities”
“Inflation is nothing more than a sharp upward rise in price
level.”
Too much money chasing too fewer goods.
Inflation is a state in which the value of money is falling i.e.
prices are rising.
TYPES OF INFLATION-BASED ON RATE
Moderate (Creeping and trotting-single digit)
Galloping (two digits or three digits)
Hyperinflation (astronomical rise)
TYPES OF INFLATION-BASED ON CAUSE
Demand Pull Inflation
Cost Push Inflation
Structural Inflation
Cartelization
Hoarding
DEMAND PULL INFLATION
Increasing government expenditure
Increasing money supply (liberal monetary/fiscal policy)
Parallel economy/black money
Increasing forex reserves
COST PUSH INFLATION
Increase in wages
Increase in taxes
Increase in prices of raw materials
Supply shocks
STRUCTURAL INFLATION
Food shortage
Scarcity of resources
Scarcity of foreign exchange reserves
TWO MEASURES OF INFLATION
WPI
CPI
HOW INFLATION IS CALCULATED
Commodity Weightage Price
(BY)
Price
(PY)
Price
Ratio
Weighted
ratio
x 60% 20 24 1.2 72
y 30% 10 11 1.1 33
z 10% 500 600 1.2 12
Total 100 117
WPI
Base year revised from 2004-05 to 2011-12 The number of items has been increased from 676 to 697
In all 199 new items have been added and 146 old items have been
dropped
Recommendations from Saumitra Chaudhuri working committee
Given by Economic Advisor (commerce ministry)
Published once a month
WPI REBASING
WPI REBASING
CPI
Previously three different types-IW,UNME and AL
Changed to CPI (C) = CPI (U)+CPI (R)
Base year was initially fixed at 2010 but again changed to
2012
Calculated by CSO
CPI Before After
Rural 437 448
Urban 450 460
CPI
Industrial
Workers (IW)
Urban Non-
Manual
Employees
(UNME)
Agricultural
Labourers (AL)
Base year 2001 1984-85 1986-87
Number of
articles
370 180 60
Services included Yes Yes No
Published by Ministry of
Labour
MoSPI Ministry of
Labour
CPI- RURAL, URBAN & COMBINED
Rural Urban Combined
Food and beverages 54.18 36.29 45.86
Pan, tobacco and
intoxicants
3.26 1.36 2.38
Clothing and footwear 7.36 5.57 6.53
Housing Not compiled 21.67 10.07
Fuel and light 7.94 5.58 6.84
Miscellaneous 27.26 29.53 28.32
COMPONENTS
Inflation Main category Sub-category
WPI Manufacturing (64%) Chemicals, textiles, wood and paper, metals
and alloys, Beverages, tobacco etc
Primary Articles (22%) Food articles, non-food articles, minerals
(crude petroleum)
Fuel (13%) Electricity, coal, mineral oils, LPG
CPI Food & Beverages (45.86%) Cereals, meat, fish, egg, milk etc
Miscellaneous (28.32%) Health, transport and communication,
education, recreation etc
Housing ((10.07%) Only in urban
Fuel & Light (6.84%) Fuel and light
Clothing & Footwear (6.53%) Clothing and footwear
Pan Tobacco and Intoxicants
(2.38%)
Pan Tobacco and Intoxicants
EFFECTS OF INFLATION
Reduces purchasing power
Reduces real rate of returns
Has an effect on exports
Effects investment scenario
HOW TO CONTROL INFLATION
Credit Control
Reduction in Unnecessary Expenditure
Increase in Taxes
Increase in Savings
Public Debt
To Increase Production
Rational Wage Policy
Demonetization of Currency
OTHER CONCEPTS
Deflation: Negative growth in the inflation rate
Dis-inflation: the rate change of inflation is slower or not
proportional
Core inflation: what is the inflation rate when volatile
commodities (such as food and energy items) are ignored
Headline Inflation: measure of total inflation in the economy
INFLATION TARGETING
Government has given the function of controlling inflation to RBI
MPFA was signed between GoI and RBI
As per this the RBI has to maintain Inflation at 4% (+/- 2%)
WPI AND CPI
PHILIPS CURVE
Represents the inverse relationship between the inflation and
unemployment rate
QUESTIONS
Which reference to inflation in India, which of the
following statements is correct? (2015)
a. Controlling the inflation in India is the responsibility of the
Government of India only
b. The Reserve Bank of India has no role in controlling the
inflation
c. Decreased money circulation helps in controlling the
inflation
d. Increased money circulation helps in controlling the
inflation
QUESTIONS
Which of the following brings out the ‘Consumer
Price Index Number for the Industrial Workers’?
(2015)
a) The Reserve Bank of India
b) The Department of Economic Affairs
c) The Labour Bureau
d) The department of Personnel and Training
QUESTIONS
Consider the following statements : (2013)
1. Inflation benefits the debtors.
2. Inflation benefits the bond-holders.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Inflation
Inflation is a persistent increase in the price levels of a basket of commodities
Price and price levels are two different things- price refers to the monetary value
that is paid/received for a good sold/bought respectively it is an individual
concept; whereas price level is an aggregate concept which is the monetary value
of basket/group of goods/services
It is important because inflation is a measure of change in the price levels as the
household buys a mix of goods and services and inflation tries to measure the
impact on the household
It is a macro-economic aggregate as it takes into consideration a basket of
commodities
Classification of inflation
o Based on the rate
Moderate-single digit inflation
Galloping-double/triple digit
Hyper-astronomical
o Based on the cause
Demand pull inflation
Increasing government expenditure
Increasing money supply (liberal monetary/fiscal policy)
Parallel economy/black money
Increasing forex reserves
Because of the above reasons the demand will go up and in this
situation there could be two outcomes- increase in the production
or increase in the prices. Since in a short run production cannot be
expanded, there will be increase in the prices.
Cost push inflation
Increase in wages
Increase in taxes
Increase in prices of raw materials
Supply side shocks
Structural inflation (is more a feature of a developing country as the
resources availability is limited for them)
Food shortage
Scarcity of resources
Scarcity of foreign exchange reserves
Reasons for inflation
o Demand pull factors-higher expenditure by government, expansionary
monetary/fiscal policy
o Cost push factors- increase in wages, increase in taxes etc
o Structural factors-lower investment, lower growth in agriculture,
unscientific storage of food grains etc
o Cartelization-suppliers come together and increase the price irrationally
o Hoarding-the middlemen store part of the goods and create an artificial
scarcity in the market
Two measures of inflation
o WPI
o CPI
WPI (Wholesale Price Index)- it measures the level of price changes at a
wholesale market level
It was reformed after the recommendations of Pronab Sen committee
o Base year changed from 1993-94 to 2004-05
o Coverage increased from 435 commodities to 676 commodities
o Published once a month
o Published by Economic Advisor
o Weightages also changed
o All the commodities which were of no daily use were taken off and new
commodities added to make it more representative
In 2017, the government has rebased the WPI and IIP
o The change of BY is from 2004-05 to 2011-12. The working committee that was set up by the government in this regard was headed by Dr Saumitra Chaudhuri
o The revision is done to reflect the changes in the industrial sector, to align it with the base year of other macroeconomic indicators like the Gross Domestic Product (GDP), Consumer Price Index (CPI-BY 2012)
o Under the new system
An institutional mechanism (Technical Review Committee) has been established
For facilitating dynamic revision of the item list of products and the panel of factories
It will be chaired by Secretary (Ministry of Statistics & PI)
This Committee will meet at least once a year for identifying new items that need to be included in the item basket and removing those that have lost its relevance in the industrial sector or are no longer being produced
The revised series will continue to represent the Mining, Manufacturing and Electricity sectors
The revised series uses the National Industrial Classification (NIC) 2008 for the purpose of classification of industrial production
The weightage given to the groups will be (for WPI will be)
Primary articles – 22.62%
Manufacturing – 64.233%
Fuel and Power – 13.15% Increase in number of items from 676 to 697. In all 199 new items
have been added and 146 old items have been dropped The new series is more representative with increase in number of
quotations from 5482 to 8331, an increase by 2849 quotations A new WPI Food Index will also be published (recommendation of
Ministry of Finance). It will be compiled by taking aggregates of WPI for food “products” under “manufactured goods” and “primary articles”
The practice of using Wholesale Price Index (WPI) to deflate items for which data is reported in value terms will continue
In the new series of WPI, prices used for compilation do not include indirect taxes in order to remove impact of fiscal policy. This is in consonance with international practices and will make the new WPI conceptually closer to ‘Producer Price Index’
o WPI and IIP is calculated by CSO o The unit coverage of IIP will, as before, cover entities in the organized
sector units registered under the Factories Act, 1948 o The weightage given to the groups will be (for IIP will be)
Mining – 14.373% (previously it was 14.157%) Manufacturing – 77.633% (previously it was 75.527%) Electricity – 7.994% (previously it was 10.316%)
CPI (Consumer Price Index)- it measures the changes in the price levels at retail
level. This inflation has the impact on the common man
o CPI previously was calculated for various groups based on their
consumption patterns
o Recently the CPI has been reformed-the base year has been shifted to
2012. Rather than having various CPIs, there are three CPIs now which are-
CPI (Urban), CPI (Rural) and CPI (Combined).
Rural Urban Combined
Food and beverages
54.18 36.29 45.86
Pan, tobacco and intoxicants
3.26 1.36 2.38
Clothing and footwear
7.36 5.57 6.53
Housing Not compiled 21.67 10.07
Fuel and light 7.94 5.58 6.84
Miscellaneous 27.26 29.53 28.32
Industrial
Workers
Urban Non-
manual
Employees
Agricultural
Laborers
Base year 2001 1984-85 1986-87
Number of
articles
370 180 60
Services
included
Yes Yes No
Published by Ministry of
Labour
MoSPI Ministry of Labour
Impact of inflation
o Reduces purchasing power
o Reduces real rate of returns
o Has an impact on exports
o Impact on investment scenario
How to control inflation
o Credit Control-through contractionary monetary/fiscal policy
o Demonetization of Currency-to control the black money
o Reduction in Unnecessary Expenditure
o Increase in Taxes
o Increase in Savings-the government has to incentivize the savings so that
expendable income reduces
o Public Debt-government should not allow the public debt to go beyond the
controllable limit
o To Increase Production-thereby reducing/moderating the prices
o Rational Wage Policy
Inflation impacts the poor, fixed income class and people in unorganized sector
as their purchasing power keeps on reducing and these groups do not have the
savings to tap into. It has very less impact on the rich class hence it could be
concluded that inflation leads to income redistribution in the favor of rich
Inflation (manageable terms always works in favor of producers, as this extra
price will act as an incentive for them to produce more
Inflation Targeting-
o As per the recommendations of Urjit Patel Committee
CPI must be used as an anchor for monetary policy (adopted by RBI)
Inflation must be maintained at 4% (+/-2%) (implemented through
MPFA)
The monetary policy decisions are to be taken my Monetary Policy
Committee (in process)
o RBI in 2015 has signed Monetary Policy Framework Agreement (MPFA)
with the Government and as per this,
it will bring down the inflation to lower than 6% by January 2016
(achieved)
And from 2017-18 the target will be 4%(+/-2%)
will publish a report every 6 months giving-reasons for inflation and
forecasts of inflation
it would have failed if inflation remains either higher than 6% or
lower than 2% for three consecutive quarters
in that case it will give a report to the government charting out the
course and specify duration within which the inflation will be
brought down
Philips Curve- represents the relationship between the inflation and
unemployment
o Rate of unemployment and rate of wage inflation are inversely related
(when there is low unemployment, the labour class is in a better position
to bargain for higher wages)
o Rate of inflation and wage inflation are directly related (higher the
increase in wage, higher demand for goods leading to inflation)
o Hence rate of unemployment and inflation are inversely related and the
representation would be a downward sloping curve
Some terms
Open Inflation- the prices of goods are allowed to fluctuate freely (or there is
least interference of the government in deciding the prices of goods)
Suppressed inflation- goods are sold at lower prices compared to the market
prices (ex-food grains sold under NFSA)
Stagflation- the period when there is inflation accompanied by increasing
unemployment and lower productivity
National Income Aggregate
Tries to measure what has been the growth in the production for comparison
with other countries and with itself over the time (i.e. to comparison over space
and time)
For measuring the production various aggregates are used
o GDP (Gross Domestic Product)
o GNP (Gross National Product)
o NDP (Net Domestic Product)
o NNP (Net National Product)
o National Income
GDP
o It is a geographic concept. It is the total monetary value of all the goods
and services which have been manufactured in a country in a financial
year
o In calculation of GDP
Intermediary goods will not be considered
savings is not considered
goods resold will not be considered (commission generated will be
considered)
social security transfers (eg-pensions) will not be considered
o Three methods to calculate GDP
Output/Product Value method=Total output × market price
Income method=sum of all the factor incomes
Expenditure method=C+I+G+(X-M)
C= consumption expenditure by households
I= Investment expenditure by firms
G= Government expenditure
X= Exports
M= Imports
GNP
o It is a nationality concept
o Under this the production done by citizens of a country is considered
o In a country there are inflows and outflows of foreign currency. The
inflows are because some nationals are working outside but are sending
back the remittances and outflows as foreign nationals are working within
but are sending back the earnings.
o Because there are such inflows and outflows, they need to be accounted
o GNP=GDP+NFIFA (NFIFA=Net Factor Income From Abroad)
o NFIFA=income earned by Indians living abroad-income earned by
foreigners living in India
NDP
o Depreciation- whenever there is usage of machinery in manufacturing,
they undergo wear and tear; and thereby lose value. This loss of value is
considered as depreciation and has to be deducted from the total value of
goods and services produced to give a better picture.
o NDP=GDP-Depreciation
NNP
o Under NNP, the production of citizens of a country is adjusted for
depreciation
o NNP=GNP-Depreciation
o NNP=GDP+NFIFA-Depreciation
National Income
o Is considered as the purest form of the income
o It is the NI=NNPFC=NNPMC - Indirect Taxes + Subsidies
o Factor cost=how much money is spent by manufacturer on all the factors
of production
Why GDP only?
o The inflows and outflows of foreign currency can happen because of
various reasons
o Depreciation rates will vary across countries
o Taxation and subsidization will vary across countries
Current prices and constant prices
o The current prices will represent the prevailing prices. If GDP is calculated
at these prices, then the inflation will not be discounted
o Hence to discount for the inflation rate the GDP is calculated at constant
prices
o And to account for inflation, GDP deflator is used
Limitation of NIA
o Non-availability of data and data collection is a costly affair
o Time lag-it takes time to collect data and arriving at numbers
o Existence of non-monetized consumption (or barter system)
o Parallel economy-the presence of black money in the economy may keep
adding to the demand side
o Lack of occupational specialization-many in India do multiple jobs rather
than sticking to a single job
Per Capita Income (PCI)-is the average income of every citizen of the country in a
particular year
PCI = National Income
Population
Some facts
o 1st estimate - Dadabhai Naoroji (1867-68)
o 1st scientific estimate - Prof V K R V Rao (1931-32)
o 1st official Estimate - Ministry of Commerce (1948-49)
o Calculation done by CSO (MoSPI)
New GDP series
The rebasing of the new GDP series is for the year 2011-12 rather than for 2009-
10 as the data regarding employment is not fully available, there was drought, it
wasn’t a normal year as there was a recession during the year 2009-10
Why the need to rebase
o The structural changes- such as technological changes leading to
production changes, relative changes in the prices of the relative goods
leading to changes in consumption side changes
o This helps in judging the size of the economy
o Which sectors are relatively important can be decided
Whenever rebasing is done
o accounting procedures change
o price indices are changed
o new estimations are used
o new databases are used
Till recently whenever the rebasing was done usually cosmetic or peripheral
changes were done but in the new NAS (National Accounts Statistics) the changes
have been comprehensive hence this has attracted a lot of attention and has led
to discussion
The Present rebasing has been done by CSO taking into consideration the
recommendations given the SNA (System of National Accounts) published by UN
in 2008. The changes introduced in the rebasing involve
o GVA as a concept comes under SNA (System of National Accounts). SNA
was prepared by UN in 1992-93, and has been ratified by WB, IMF, ADB
etc
o Replaced the old base year 2004-05 (decided in 2010) with 2011-12 (in
2015)
o Along with this there have been changes even in the coverage. The old
series covered 8 industries whereas the new covers 11 industries
o GDP at Factor Cost will be replaced with GVA at Basic Prices (The factor
cost do not consider the indirect taxes and subsidies whereas both are
considered under GVA at Basic Prices).
o GDP at Market Costs henceforth will be referred to as GDP
o Gross value added (GVA) is broadly defined as the value of output less the value of intermediate consumption. It measures the contribution to an economy of an individual producer, industry, sector or region
o Production taxes and production subsidies are either paid/received and are
independent of volume of any goods produced.
Production taxes - land revenues, stamps and registration fees and
professional tax etc
Production Subsidies - subsidized to Railways transportation, input subsidies
to farmers, subsidies given to small industries, subsidies given to companies
etc
Product taxes or subsidies are paid/received on per unit of product.
Product taxes - excise tax, sales tax, service tax and import and export duties
etc
Product Subsidies - petroleum and fertilizer subsidies, interest subsidies given
to farmers etc
o The coverage has been increased (Previously RBI used to cover the data
through ASI but has been shifted to MCA21)
o The ASI used the concept of ‘establishment’ (each unit’s GVA was taken into
consideration) whereas the new methodology uses ‘enterprises’ (under this
the parent company’s GVA is taken into consideration which adds to services
such as advertising, accounting, marketing etc) approach. Hence the size of
GVA under the second method will be larger than the first
o The calculation of labour in the previous methodology was based on Labour
Input method (LI Method) wherein the marginal productivities of labour were
not considered whereas in the new methodology Effective Labour Input (ELI)
is used.
Arguments - In 2015-16, India clocked a GDP growth rate of over 7.5% but the
exports had fallen, investments were at the lowest ebb and IIP growth rate gave
a completely different picture. One of the reasons for this diversion is considered
to be the GDP deflator. In case of India, we use the WPI (along with CPI) as the
deflator to deflate the nominal numbers but the WPI does not consider the
services and it is mainly oriented towards commodity prices
Producer Price Index
o PPI measures price changes from the perspective of the seller
o Sellers’ and Purchasers’ prices vary as there are taxes and subsidies
o The WPI does not cover services, whereas the PPI covers services
o Many countries have adopted PPI
o The government in 2014 has set up 12-member committee headed by B
N Goldhar to recommend regarding forming a PPI for India (determining
its methodology, data needed for its construction, and selecting a base
year among other things). It’s not the first time as even before two
committees under the Planning commission have been set up to study
regarding forming a PPI for India-one was headed by Abhijit Sen and the
other by Saumitra Chaudhuri
NATIONAL INCOME
AGGREGATES
BY
SHYAM S KAGGOD
POINTS TO BE COVERED
Why
Types
New GDP Methodology
Questions
AGGREGATES USED
GDP (Gross Domestic Product)
GNP (Gross National Product)
NDP (Net Domestic Product)
NNP (Net National Product)
NI (National Income)
GDP
Total monetary value of all the goods and services produced
within a geographical area within a time period
Three Methods
Output/Product Value method=Total output*market price
Income method=sum of all the factor incomes
Expenditure method=C+I+G+(X-M)
Cost on the company FoP Revenue to the providers
Rent Land Rent
Salary/wage/income Labour Salary/wage/income
Interest Capital Interest
Profit Entrepreneurship Profit
Total cost of productionTotal income received
Calculation of National Income
goods
expenditure
NEW METHOD OF MEASUREMENT
The base year was changed from 2004-2005 to 2011-12
SNA-The SNA was prepared by UN, launched in 1992 and
upgraded in 2008. ratified by WB, IMF, OECD etc
Methodological changes
Shifted from cost price to market price
Coverage has shifted to MCA21 data (ASI to MCA21)
New concept of GVA introduced
New concept of Basic Prices introduced
GROSS VALUE ADDED
Miner Steel
Manufacturer
Utensil
Manufacturer
Intermediate
Goods
00 10 30
Market Prices 10 30 50
Value Added 10 20 20
Value Added=Total Consumption-consumption of Intermediate goods
GDP NEW SERIES
GVABP = GVAFC + Production taxes – Production Subsidies
GDPMP = GVABP + Product Taxes – Product Subsidies
CONCERNS
Discrepancies
The GDP numbers do not reflect the other realities (such as
bank loans growth rate, corporate sector profitability,
industrial growth etc)
GDP-DISCREPANCY
GDP DISCREPANCY
GDP DEFLATOR
Used to adjust for inflation
In case of India WPI is used (in developed countries PPI is
used)
GoI has set up a committee under B N Goldhar
GNP
Total monetary value of all the goods and services by the normal
residents of a country within a financial year
GNP=GDP+NFIFA
NFIFA=FIRILA-FIPFLI
NFIFA=net factor income from abroad
FIRILA=factor income paid to Indians living abroad
FIPFLI=factor income paid to foreigners living in India
NDP
Depreciation is the expenditure in the form of lower value of
machinery, repairs etc
Hence depreciation has to be accounted as it reduces the profit
margins
NDP = GDP - Depreciation
NNP
Accounting for depreciation out of the total production done by
Indians
NNP = GNP - Depreciation
National Income or NNPFC
NNPFC=NNPMC - Indirect Taxes + Subsidies
It is the purest form of an income of a country as it takes
into account depreciation, the indirect taxes as well as the
subsidies
LIMITATIONS OF NIA
Non-availability of data
Time lag
Existence of non-monetized consumption
Parallel economy
Doesn’t consider development, environmental impact etc
PER CAPITA INCOME
Is the average income of the citizen of a country in a year
It is a representative number
PCI
SOME FACTS
1st estimate-Dadabhai Naoroji (1867-68)
1st scientific estimate- Prof V K R V Rao (1931-32)
1st official estimate-Ministry of Commerce (1948-49)
Calculation done by CSO (MoSPI)
Base year used= 2011-12
QUESTIONS
The national income of a country for a given period is
equal to the (2013)
(a) total value of goods and services produced by the nationals
(b) sum of total consumption and investment expenditure
(c) sum of personal income of all individuals
(d) money value of final goods and services produced
CAPITAL, SAVINGS AND INVESTMENT
BY
SHYAM S KAGGOD
GROSS CAPITAL FORMATION
Gross Savings
Private
Households
(Financial and Physical)
companies
Public
GROSS CAPITAL FORMATION
Of the total production, part is consumed and whatever is left out is
referred to it as savings. This could be either in Public or Private
sector. Whatever is invested back from this is referred to as capital
formation
This ratio is one of the indicators of health of the economy
YEAR GCF
2012-13 38.6
2013-14 34.7
2014-15 34.2
GROSS CAPITAL FORMATION (GCF)
GCF
GFCF
Infrastructure such as building,
machinery, means of transport, roads,
canal etc
Stock
Change in raw materials,
inventories, finished/semi-
finished goods etc
GROSS FIXED CAPITAL FORMATION
SAVINGS AND INVESTMENT
SAVINGS AND INVESTMENT
2003 (% of GDP) 2007 (% of GDP) 2017 (% of GDP)
GFCF 26.5% 35.6% 26.4%
Domestic Savings 29.2% 38.3% 29% (for 2016)
SAVINGS & INVESTMENT
CHANGES IN SAVINGS/INVESTMENTS
CONNECTION BETWEEN INTEREST RATES AND INVESTMENTS
Fisher Equation
r=n-i
r=real interest rate
n=nominal rate of interest
i=inflation rate
CONNECTION BETWEEN INTEREST RATES AND INVESTMENTS
Projects Investment Project
Returns
Real Interest
rates
Total investment
A 10 Cr 7% 5% 810 Cr (A+B+C+D)
B 20 Cr 9% 8% 800 Cr (B+C+D)
C 300 Cr 8% 9.5% 480 Cr (D)
D 480 Cr 10% 11% ₹ 0 Cr
The inflation rate between FY14 to FY16 has declined by 900 bps (WPI) or by 500 bps
(CPI) whereas, the repo rate has been reduced by 125 bps
This increase the cost of the borrowing for industries hence lesser borrowing
r n i
3% 8% 5%
4% 7% 3%
QUESTIONS
Economic growth in country X will necessarily have to occur
if (2013)
(a) there is technical progress in the world economy
(b) there is population growth in X
(c) there is capital formation in X
(d) the volume of trade grows in the world economy