Dr Archana P i l l a i

IMT Hyderabad

Inflation Measures, Money Demand and Production

Linkages

Inflation

Outside a shop where Christmas trees are being sold…

“Is it going to be the same size as last year or the same price as last year?”

Sustained increase in the general price levelGeneral Price Level – measured as consumer

prices and wholesale prices/industrial goods prices

More about value of money than about value of goods

Related concepts

Velocity of money (P *Q)/M = V MV = PY (Fisher Equation)

Money Neutrality Assumes no role of money in the effect on real output Short run changes do happen Assumes no effect on production, wages and interest

rates Weak concept

Types of inflation

CreepingCrawlingGallopingHyperinflationStagflation

Cost pushDemand pullHeadline vs Core (WPI – food and fuel)

Cost push Inflation

Comes through increases in factor prices Wages Raw materials Affects the Aggregate supply Affects productivity

Wage push inflation Profit push inflation

By oligopolists or monopolists – greed to get more Wage price spiral

Demand pull Inflation

Comes through increased goods demand Change in the Aggregate Demand function Changes in interest rates can affect demand Govt expenditure shifts AD Excessive foreign inflows affect AD

Inflationary gap The amount by which AD exceeds aggregate output at

full employment level Causes inflationary spiral

Effects of Inflation

Income distribution Producers – profit earners gain

Wage Earners Depends on bargaining power

Retired/Aged Suffer from low value of savings

Investors Equity – gain; Interest earners – lose

Debtors/Creditors Debtors – gain; creditors - lose

Effects…

Rent earners Fixed contracts – hurt

Effect on Wealth distributionEffect on Output and Employment

Leads to improvement in resource allocation Negative in terms of productivity losses

Deflation

Persistent and appreciable fall in pricesWhere AD falls short of available outputPessimismLeads to idle capacity in various sectorsReverse multiplier gets into actionMEC falls

Inflation vs Deflation – former preferred (Why??)

Stagflation

Unemployment, lack of growth and inflationRise in prices – causes fall in outputExpectations of future prices – also downwardNo incentive to borrow – since costs are highNo incentive to produce – since demand is lowNo incentive to consume – since prices are high

Kind of very low economic equilibrium – experienced by developed economies – US and Germany

Other costs..

Shoeleather Costs Resources wasted when inflation encourages people

to reduce their money holdings and keep more money in banks (interest bearing assets)

Menu costs Costs of changing prices Printing, informing – customer annoyance costs

Consumer Price Index

CPI – IW The CPI-IW purports to measure the temporal change in the

retail prices of fixed basket of goods and services being consumed by the target group i.e. an average working class family and thus, is an important indicator of the retail price situation in the country.

Used for determination of DACPI – AL/RW – to be done away withCPI – UrbanCPI – RuralCPI - combinedBase year 2013-14 = 100 (New)http://labourbureau.nic.in/indexes.htm

CPI - Weights

Food, Beverages and tobacco (49.71)Fuel and light (9.49)Clothing, bedding and footwear (4.73)Housing (9.77)Misc (26.31)

Conduct of Income and Expenditure Survey (NSSO)

Organisation of price collection workHouse Rent surveys – rented and self-owned

CPI..

Base year fixationMethod – Base year price * Base year

quantity; Current year price* Base year quantity

New base year 2010 – released in Feb 2011310 towns – 1114 price schedules – on

average 250 items per monthCPI (Rural) – 1181 villagesPrice collectors – Post officials

Wholesale Price Index (2004-05)

Rationale to Compute WPIConcept of wholesale price

Agricultural commodities Non – agricultural (ex-factory gate price)

Wholesale price vs producer price – latter includes taxes and transport charges

Selection of items (total number of items – 676 in basket) Agricultural items (M/O Agriculture), National Horticulture

Board, Spices Board, Tea board, Coffee Board and Rubber Board, Silk Board, Directorate Of Tobacco, Cotton Corporation of India )

Organized manufacturing

WPI…

ASI PricesUnorganized/unregistered manufacturing -

Own Account Enterprise (OAE), Directory Manufacturing Establishment (DME) and Non-Directory Manufacturing Establishment (NDME), Economic Census and its follow up surveys and Census of Registered SSI units

WPI groups

Primary ArticlesFuel, Power, Light and LubricantsManufactured Products

Weightages – 20.11, 14.91 and 64.97Refer doc WPI weights - observations

WPI vs CPI

Why different measuresImportance of bothMeasurement in India

Need for a consolidated indexCPI (Rural + Urban)

Index of Industrial Production

Index of Industrial Production (IIP) is an abstract number, the magnitude of which represents the status of production in the industrial sector for a given period of time

Basic goodsCapital goodsIntermediate goodsConsumer durablesConsumer non-durables

IIP..

543 itemsMethod of data collection – ASI dataWPI deflators – 2004-05 usedIndex of 6 core industries

26.7% weight – growth of 6.8% over previous year Crude Oil, Petroleum Refinery Products, Coal,

Electricity and Cement and Finished SteelRelevance of measureUsefulnessDrawbacks

Relevant websites

www.labourbureau.gov.inwww.data.gov.inwww.indiabudget.nic.inwww.eaindustry.nic.inwww.rbi.org.inFor class tomorrow – readings on the RBI

website – money supply