Inflation

The macroeconomic causes of inflation are complex, but its effects on individuals are straightforward and severe. While the wealthy may be insulated, the middle class and those in the lowest financial strata bear the brunt of inflation. For some households, coping with rising prices is nearly impossible, leading to starvation, malnutrition, and a profound sense of helplessness.

So, what is inflation, and why does it matter? Inflation refers to the rising prices of goods and services over time, measured against a previous baseline, in relation to income levels. While inflation affects nearly every category of goods and services, its impact varies. For instance, inflation in food prices is more harmful than in clothing because food is essential for daily survival, unlike clothing, which is not needed as frequently. Similarly, inflation in luxury items has a smaller impact compared to essential goods like clothing. People can forgo luxury purchases, but they cannot avoid buying necessities.

How is inflation calculated? Well, the govt of India like any other country calculates inflation including consumer price index and wholesale price index. The govt also uses a basket of items on which the calculations are done. The basket includes items like food, housing, clothing, transportation, medical care, and education. Inflation is primarily measured and managed by 5 govt institutions like the Reserve Bank of India, Ministry of Statistics and Programme Implementation (MoSPI), Ministry of Commerce and Industry, Ministry of Finance and Ministry of Consumer Affairs, Food and Public Distribution. The economic policies and strategies of the Indian government and handled by the office of the chief economic advisor. The CEA advises the government on a wide range of economic policies, including fiscal policy, inflation management, and international trade.

Cost/Supply-Push and Demand-Pull Inflation

Cost/Supply-Push Inflation: Occurs when the costs of production for goods and services increase, leading businesses to raise prices to maintain profit margins. This could be due to rising labor costs, raw material prices, or supply chain disruptions.

Demand-Pull Inflation: Occurs when demand for goods and services exceeds supply, causing prices to rise. This can be triggered by an increase in consumer spending, government spending, or investment.

Simplistic Calculation of Inflation

I am referring to a simplistically represented calculation for inflation , published by Professor Satish Deodhar, Indian Institute of Management Ahmedabad.

Let's assume the consumer basket has 2 commodities- food and clothing. The price of food on 01-Jan, 2009 was Rs 80 and that of clothing as on the same date was Rs 90. Say the price increases to 100 and 99 as on 01-Jan, 2010. Hence the % price increase of food between 2009 to 2010 was ((100-80)/80)*100=25% and clothing was ((99-90)/90)*100=10%. The arithmetic average increase= (25+10)/2=17.5 %. This can be further represented as 1/2*(25) + 1/2(10)=17.5 . This means that an equal weightage of 1/2 has been assigned to both price rises.

But in real life, a person does not spend equal income on food and clothing. People does need new clothes everyday, but need a constant supply of food materials to survive, so naturally the expenditure on food is more than clothing. Lets assume a person consumes 5 units of food and 2 units of clothing. Expenditure in 2009 is 80*5=400 on food and 2*90=180 on clothing. The fractional expenditure on food=400/(400+180)=.69 and for clothing=180/(400+180)=.31 .Hence the general price % rise obtained earlier can now be weighed as .69*25%=17.25 for food and .31*10%=3.1 . Total price rise=17.25+3.1 = 20.35. So clearly, after introducing the unequal quantities of consumption, the general price rise % is now 20.35 , while when equal weightage was given, it was 17.5 , an increase by 2.85 . This is how inflation rate is calculated by the govt. After calculating the inflation, the govt comes up with the general price level in the economy. To calculate that, the price level in the base year is always assumed to be 100. Assuming the price level in 2009 was 100, the general price level index in 2010=Base value+inflation=100+20.35=120.35 .

I am also mentioning an alternate formula for calculating the price level index.. The Laspeyres Index, coined by German economist Etienne Laspeyres. As per the formula:

Price index in year T=(Sum(Price of goods in year T)*Quantity of consumption in base year)) / (Sum(Price of goods in base year)*Quantity of consumption in base year))

Calculation of Inflation using CPI

Lets take the same example from previous section. The basket contains 5 units of food and 2 units of clothing. Its overall price in 2009 =(80*5 + 90*2)=580 . Overall price on 2010=(100*5+99*2)=698.

CPI=(Cost?of?Market?Basket?in?Current?Year/Cost?of?Market?Basket?in?Base?Year)×100=698*100/580=120.34

So, the CPI for 2010 is 120. This means that the overall price level has increased by 20% since the base year 2020.

Now having calculated the CPI, lets try find the inflation.

Inflation?Rate=(CPI?in?Current?Year?CPI?in?Previous?Year/CPI?in?Previous?Year)×100

Putting in the values in the above equation will help find the inflation in percentage.

Alternate Calculation of Inflation - Quantity Theory

This theory links the money supply with nominal GDP and price levels (which relate to inflation).

MV=PY

• M = Money supply
• V = Velocity of money
• P = Price level (a measure of inflation)
• Y = Real GDP

Rearranging this, we get the inflation rate (P) in terms of money supply, velocity, and GDP:

P=MV/Y

This shows that if the money supply (M) grows faster than real GDP (Y), inflation (P) will tend to increase.

Macroeconomic Analysis of Indian Inflation between 2020 and 2024

Before delving into this analysis, let us study the 2 key indexes that are used for measuring inflation. I have made a mention of both in the introduction section of this article. I have also mentioned that the dataset on which the CPI is calculated is termed as a basket of goods and services and contains price levels of food, housing, clothing, transportation, medical care, and education. And lastly, we have seen in the previous section that inflation is calculated with respect to a baseline, termed as the base year.

The consumer price index measures the change in the price level of a basket of consumer goods and services purchased by households. It reflects the cost of living and directly impacts consumers. On the other hand, the wholesale price index (WPI) measures the change in the price of goods at the wholesale level, i.e., before they reach the retail level. It reflects the prices of goods sold in bulk and is an indicator of price movement in the economy at an earlier stage. The basket used to calculate WPI includes items like manufactured products, primary articles (such as agricultural goods), and fuel.

CPI= ((Current?Year?Price?of?Basket) / (Base?Year?Price?of?Basket))×100

WPI= ((Current?Year?Price?of?goods) / (Base?Year?Price?of?Goods))×100

• Year 2020 to 2021 : The Indian economy faced a severe contraction in 2020 due to the COVID-19 pandemic. The nationwide lockdown imposed in March 2020 led to a sharp decline in economic activity across sectors, with GDP shrinking by about 7.3% in the fiscal year 2020-21, marking the first contraction in nearly four decades. The services sector, particularly tourism, hospitality, and retail, was hit hardest, while the industrial sector also saw significant declines in output due to supply chain disruptions.
• Year 2021 to 2023 : The surge in global crude oil prices, driven by supply constraints and geopolitical tensions, had a direct impact on India's inflation. As a major importer of oil, India faced higher fuel costs, which fed into transportation and production costs across the economy, leading to broad-based inflation.
• Year 2022 to 2023 : India witnessed elevated inflation, primarily driven by supply-side disruptions, food price volatility, and global commodity price fluctuations. This was partly due to the lingering effects of the Russia-Ukraine conflict, which affected global supply chains and led to higher prices for energy and food.
• Year 2024 : By early 2024, inflation showed signs of moderation as global commodity prices stabilized and domestic supply-side interventions, including export restrictions on certain commodities and increased imports, began to take effect.

Inflation in an economy has a complex but cognizable relationship with the Gross Domestic Product(GDP). High economic growth substantiating high GDP can lead to inflation. This is because when the economy grows, it puts in more money in the hands of people. This increases demand in the economy as people have more disposable income. Increasing demand pushes the price level of commodities upwards, leading to inflation. Governments around the world and in India as well are accused of neglecting inflation in the pursuit of chasing higher GDP. High GDP is often used by the governments as a measure of their performance and are used to win votes. Such actions often undermines the inflation associated. Because, when inflation rises quickly, it can erode purchasing power, reduce consumer and business confidence, and lead to uncertainty in the economy. This can result in reduced investment and consumption, ultimately slowing GDP growth.

Lets analyze the economic activity in India during the pandemic, year 2020-21.

• As per the Ministry of Statistics & Programme Implementation release, real GDP or GDP at constant (2011-12) prices for the years 2020-21 and 2019-20 stands at ?135.58 lakh crore and ?145.16 lakh crore, respectively, showing a contraction of 6.6 per cent during 2020-21 as compared to growth of 3.7 per cent during 2019-20.
• Nominal GDP or GDP at current prices for the year 2020-21 is estimated at ?198.01 lakh crore as against ?200.75 lakh crore for the year 2019-20, showing a contraction of 1.4 per cent during 2020-21 as compared to growth of 6.2 per cent during 2019-20.

Hence , Deflator during 2020-21= (198.01/135.58)*100= 146.04

Deflator during 2019-20 = (200.75/145.16)*100=138.3

Change?in?Deflator=Inflation=(GDPDeflatorYear2-GDPDeflatorYear1/GDPDeflatorYear1)×100

Hence the inflation during 2020-21 with respect to 2021-22=((146.04-138.3)/138.3)*100 = 5.6.

This shows, price inflation rose by 5.6% during 2020-21 with respect to 2019-20 .

In conclusion, the analysis of Indian inflation during the COVID-19 pandemic underscores the unprecedented challenges faced by the economy. The pandemic-induced disruptions led to a complex interplay of supply-push inflation, driven by supply chain breakdowns and rising input costs, alongside demand-pull pressures as the economy began to recover. The sharp rise in food and fuel prices further exacerbated inflation, straining household budgets and complicating policy responses. Navigating through this period required careful balancing by policymakers to support economic recovery while containing inflationary pressures, highlighting the need for resilient supply chains and adaptive economic strategies in the face of global crises.

Inflation Control

The govt in unison with the reserve bank of India can control inflation in many ways. I will list down the various means as bullet points.

• The government can boost the production of essential goods by providing incentives to farmers, manufacturers, and businesses.
• In situations where domestic production is insufficient, the government can encourage imports by reducing import duties on essential goods.
• The government can implement and enforce laws that prevent hoarding and profiteering, especially during periods of scarcity.
• The government can regulate the prices of essential commodities through mechanisms like the Essential Commodities Act.
• RBI increase the repo rate to make borrowing expensive for commercial banks. In turn the interest rate for public lending will also increase , leading to lesser liquidity in the market.
• RBI increase reverse repo rate, increasing lending more money by commercial banks to RBI,thus reducing liquidity for public borrowing.
• RBI increase the cash reserve ratio, so that commercial banks have to reserve more with RBI, thus reducing liquidity for public lending.

IT Industry Influence on Inflation

The impact of the IT industry on inflation is often discussed as an indirect effect. Higher average wages in the IT sector compared to other industries lead to increased consumer spending and higher market demand. When demand outstrips supply, prices tend to rise, contributing to inflation.

However, it’s important to differentiate between nominal wages and real wages. While nominal wages may appear to increase, inflation reduces their real value. As inflation rises, the purchasing power of wages decreases, narrowing the gap between wage increases and the cost of goods and services.

For instance, consider India’s Consumer Price Index (CPI) data, which provides insights into inflation trends. Here are some key CPI figures for recent years to illustrate the relationship between inflation and wages.

Key Figures:

• IT Sector Contribution to GDP: 7.7% (FY2023)
• Average IT Salary: ?1,000,000 per annum
• Average Salary Increase: 8-10% annually

Let's consider year 2022, when the CPI was at 6.7% .

Considering 2021 as the base year, lets consider that the yearly income of an IT professional was 1,000,000 per annum. The employee gets a hike that is average of 8 to 10% = 9%. Nominal?Wage?Increase=((New?Wage?Old?Wage)/Old Wage)*100 = (90,000/1000000)*100=9% = .09 , same as what I mentioned above.

Inflation=6.7% = .067

Real?Wage?Increase= (1+Nominal?Wage?Increase)/(1+Inflation?Rate)-1 = (1+.09/1+.06)-1 = .02 = 2% .

Similarly, considering 2022 as the base year and 2023 as the actual year and a CPI inflation of 5.4(.054) , real wage increase= (1+.09)/(1+.05)-1 = .038 = 3.8% .

Therefore, although the employee received a 9% year-over-year salary increase, the effective increase was only 2% in 2022 and 3.8% in 2023 after accounting for inflation. Thus, rather than being the cause of inflation, the employee is more accurately a recipient of its effects.

Inflation at Play - Top 20

1. Zimbabwe’s Billion-Dollar Bills: Hyperinflation led to the issuance of 100 trillion Zimbabwean dollar bills, which became collector’s items and were used as novelty gifts or wallpaper.
2. Weimar Republic Hyperinflation: In post-World War I Germany, people used wheelbarrows of cash for basic purchases, and banknotes were sometimes used as building material due to their low value.
3. Venezuela’s Mega Bills: Venezuela issued increasingly large denominations due to severe inflation, and people resorted to using U.S. dollars or bartering to avoid handling stacks of worthless currency.
4. The Banana Republics: Central American countries with unstable economies were humorously called "banana republics," a term that became a pop culture symbol of economic instability.
5. The Superdollar Phenomenon: High-quality counterfeit $100 bills were produced in the 1990s, so convincing that even experienced cashiers struggled to distinguish them from real money.
6. Post-Civil War Scrip Inflation in America: During the American Civil War, rapidly devalued scrip was used as a joke, for wrapping paper, or as emergency currency.
7. North Korea’s Economic Oddities: State-controlled prices in North Korea often differ from market realities, creating surreal situations where goods are both "priceless" and "free."
8. The Coca-Cola Inflation Index: Some countries use the price of Coca-Cola to track inflation. During hyperinflation, a Coke can becomes absurdly expensive, serving as a humorous economic indicator.
9. Argentina’s 1980s Hyperinflation: Extreme inflation led to bizarre pricing, with prices sometimes quoted in terms of "monthly wages" due to rapid changes.
10. Iran’s Gasoline Price Surges: Dramatic price changes in gasoline during high inflation led people to store extra gasoline in plastic containers to avoid future price hikes.
11. The 2008 Icelandic Financial Crisis: Following a banking collapse, Iceland’s króna devalued so much that residents humorously referred to their money as "play money."
12. The Greek Crisis and €1 Coffee: During Greece’s financial crisis, inflation caused coffee prices to soar, making a cup of coffee more expensive than a meal in some areas.
13. Bolivia’s Hyperinflation of the 1980s: Extreme inflation led to high-denomination banknotes, including a practically useless 1 million bolivianos bill.
14. Turkey’s 2018 Currency Crisis: The Turkish lira sharply depreciated, leading to it being humorously referred to as “fake money” due to its instability.
15. The 1920s Hungarian Inflation: Post-World War I Hungary experienced hyperinflation, with bread costing billions of peng?, becoming a running joke about inflation.
16. The 2001-2002 Argentine Crisis: Severe inflation and peso devaluation led people to use pesos as kindling due to their negligible value.
17. The Philippines’ 1940s Inflation: During World War II, inflation in the Philippines led to people using currency for origami and decorative items.
18. The Soviet Union’s Ruble Crisis: High inflation in the Soviet Union caused rapidly changing prices, with rubles often referred to as "paper money" in jokes.
19. Myanmar’s 2007 Inflation Crisis: High inflation led to protests, with people humorously tossing cash in the streets to symbolize its worthlessness.
20. The 2010-2011 South Sudan Inflation: Severe inflation after South Sudan’s independence led to currency devaluation so extreme that it was used as makeshift art supplies.

Conclusion

Inflation, both in India and globally, presents a multifaceted challenge with far-reaching implications. In India, the interplay of domestic policies, external pressures, and sector-specific factors and employment levels have shaped the inflationary landscape. The Reserve Bank of India and the government employ various measures to manage inflation, including monetary policy adjustments and fiscal interventions. However, the effectiveness of these measures often hinges on a delicate balance between stimulating economic growth and curbing price increases.

Globally, inflationary phenomena have ranged from the absurdly high denominations of Zimbabwean banknotes to the humorous anecdotes of hyperinflation in Weimar Germany and Argentina. Each case highlights the diverse ways inflation can impact economies and everyday life, from using wheelbarrows full of cash for basic purchases to referring to currency as "play money" in Iceland. These examples underscore how inflation can transform from a serious economic issue into a source of remarkable and sometimes amusing historical anecdotes.

The broader implications of inflation reveal its capacity to affect everything from consumer behavior to international economic stability. While inflation can erode purchasing power and create financial instability, it also provides a lens through which to understand the resilience and adaptability of economies and individuals alike. As nations navigate the complexities of inflation, both past and present, the lessons learned offer valuable insights into managing economic stability and fostering sustainable growth in an ever-evolving global landscape.