Inflation and Price Indices: CPI and WPI
Inflation is the rate at which the general level of prices rises, and it touches every part of the economy, from a household budget to the interest rate on a loan. For competitive examinations it is a rich topic because it combines definitions, causes, effects and measurement agencies, and because it is regularly in the news. Questions usually ask which index is used for a particular purpose, who releases it, what the base year is, and who gains or loses when prices rise. These notes cover the meaning and types of inflation, the different price indices, India's inflation-targeting framework, and the traps that appear in exams.
What is inflation and why does it matter?
Inflation is a sustained and general rise in the price level, which means that each rupee buys less than before. A single price going up is not inflation; the rise must be broad and continued. When prices rise, the purchasing power of money falls. Mild inflation of about two per cent is often considered normal in a growing economy. Deflation is the opposite, a sustained fall in prices, which discourages production and can deepen a slowdown. Disinflation is a reduction in the rate of inflation, not a fall in prices. Stagflation is the difficult combination of high inflation, high unemployment and stagnant growth. Reflation is a deliberate policy of increasing demand to lift an economy out of deflation.
Causes and types of inflation
On the demand side, demand-pull inflation occurs when total demand in the economy grows faster than the supply of goods, often because of heavy government spending, credit expansion or a rise in exports. On the supply side, cost-push inflation is caused by rising costs of production such as higher wages, costlier raw material or an increase in oil prices. Imported inflation enters through costlier imports, and structural inflation arises from bottlenecks in supply, poor infrastructure or hoarding. In India, food and fuel shocks and the monsoon have historically been major drivers of price swings.
Effects: who gains and who loses
Inflation redistributes income. Debtors gain because they repay loans in money that is worth less, while creditors lose. People on fixed incomes, such as pensioners and salaried employees without dearness allowance, suffer the most, as do savers holding cash or fixed deposits. Traders and producers whose prices rise faster than their costs usually benefit, and governments gain through higher tax collections and reduced real value of public debt. This is why every government tries to keep inflation moderate and stable.
The Wholesale Price Index (WPI)
The Wholesale Price Index measures the change in the prices of goods traded in bulk in the wholesale market, before they reach the retail consumer. It is released monthly by the Office of the Economic Adviser in the Ministry of Commerce and Industry. The present series uses 2011-12 as the base year and covers 697 commodities. The WPI is divided into three major groups: primary articles, fuel and power, and manufactured products, with manufactured products carrying the largest weight. A crucial limitation is that the WPI excludes services altogether and does not reflect the prices a household actually pays at the shop, which is why it is no longer the single headline measure for policy.
The Consumer Price Index (CPI)
The Consumer Price Index measures the change in the retail prices of a fixed basket of goods and services consumed by households, and is therefore the index that reflects the cost of living. The National Statistical Office releases the CPI with 2012 as the base year and publishes it separately for rural and urban areas as well as a combined series. Alongside this, the Labour Bureau compiles CPI for Industrial Workers, Agricultural Labourers and Rural Labourers, with CPI-IW presently using 2016 as the base. Because the CPI includes food and services, it catches the price rise that the WPI misses, and it is the index the Reserve Bank of India watches for its inflation target.
Inflation targeting in India
India adopted a flexible inflation-targeting framework through an amendment to the Reserve Bank of India Act in 2016. The framework sets a target of four per cent consumer price inflation, with a tolerance band of two percentage points on either side, that is a range of two to six per cent. A six-member Monetary Policy Committee, chaired by the RBI Governor, decides the policy interest rate to keep inflation within this band. If inflation stays outside the band for three consecutive quarters, the RBI must explain the failure to the government. This framework gives the RBI a statutory mandate for price stability while keeping in mind the objective of growth.
Key facts at a glance
- Inflation: sustained rise in the general price level, reducing purchasing power.
- Deflation: sustained fall in prices; disinflation: fall in the rate of inflation.
- Stagflation: high inflation with high unemployment and stagnant growth.
- Demand-pull and cost-push are the two main types of inflation.
- WPI: released by the Office of the Economic Adviser, Ministry of Commerce and Industry.
- WPI base year 2011-12; 697 items; no services.
- WPI groups: primary articles, fuel and power, manufactured products.
- CPI: released by the National Statistical Office (MoSPI), base year 2012.
- CPI-IW: compiled by the Labour Bureau, base year 2016.
- RBI inflation target: 4 per cent CPI, band of 2 to 6 per cent.
- Monetary Policy Committee: six members, chaired by the RBI Governor.
- Inflation targeting adopted through the RBI Act amendment of 2016.
- Core inflation excludes volatile food and fuel prices.
Quick revision points
- Debtors gain and creditors lose during inflation.
- Fixed-income earners and cash savers are the worst hit.
- CPI is a retail or cost-of-living index; WPI is a wholesale index.
- WPI has no services; CPI includes services.
- CPI is used for inflation targeting; WPI is used for wholesale price analysis.
- The GDP deflator covers the whole economy, unlike both CPI and WPI.
- Headline inflation includes all items; core inflation removes food and fuel.
How to prepare this topic
- Learn the differences between inflation, deflation, disinflation and stagflation with one line each.
- Memorise the agency, base year and coverage of WPI and CPI.
- Note who gains and who loses, since this is a repeated question.
- Remember the inflation target, the band and the composition of the MPC.
- Practise numerical questions on the inflation rate using the index formula.
- Follow monthly CPI and WPI news so the current figures stay fresh.
Common exam traps
- Thinking WPI is released by the RBI; it is released by the Ministry of Commerce and Industry.
- Assuming WPI includes services; it does not.
- Confusing the CPI base year (2012) with the WPI base year (2011-12).
- Mixing up the inflation target of four per cent with the tolerance band of two to six per cent.
- Saying prices fall during disinflation; only the rate of rise slows down.
- Believing creditors gain during inflation; in fact debtors gain.
Frequently Asked Questions
What is the main difference between WPI and CPI?
The Wholesale Price Index measures price changes in the wholesale market and covers only goods, not services, while the Consumer Price Index measures retail prices of a basket of goods and services actually consumed by households. Because the CPI reflects the cost of living, it is used by the Reserve Bank of India for inflation targeting, whereas the WPI is used mainly for analysing wholesale price trends.
Who releases the CPI and the WPI in India?
The Consumer Price Index is released by the National Statistical Office under the Ministry of Statistics and Programme Implementation. The Wholesale Price Index is released by the Office of the Economic Adviser in the Ministry of Commerce and Industry. The CPI-IW for industrial workers is compiled separately by the Labour Bureau.
What is India's inflation target and who decides it?
India's flexible inflation-targeting framework, adopted through the Reserve Bank of India Act amendment of 2016, sets a target of four per cent consumer price inflation with a tolerance band of two to six per cent. The target is set by the government in consultation with the RBI, and the six-member Monetary Policy Committee chaired by the RBI Governor takes the decisions needed to achieve it.
Who gains and who loses from inflation?
Debtors gain because they repay loans in money of reduced value, while creditors lose for the same reason. People on fixed incomes such as pensioners, and savers holding cash or fixed deposits, lose purchasing power, whereas traders and producers who can raise their prices faster than their costs tend to gain. Moderate inflation is therefore accepted, but high inflation harms most households.
What is core inflation?
Core inflation is the rate of inflation calculated after excluding the most volatile items, typically food and fuel, from the price index. It is used because food and fuel prices can swing sharply due to seasonal or global factors and can hide the underlying trend. A rising core inflation figure usually signals that price pressure is spreading through the whole economy.