Inflation: Types, Causes and Measurement
Inflation is a sustained rise in the general price level. Understand its types, causes, how India measures it (CPI and WPI), and how the RBI controls it.
Key Takeaways
- Inflation is a sustained increase in the general price level, reducing the purchasing power of money.
- India measures retail inflation using the CPI (base year 2012) and wholesale inflation using the WPI (base year 2011–12).
- The RBI's flexible inflation target is 4% with a tolerance band of +/- 2%, set under the Monetary Policy Framework.
Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services — that is, inflation reflects a decline in the purchasing power of money.
Types of Inflation
By Rate of Increase
| Type | Description |
|---|---|
| Creeping | Slow and mild (up to ~3% per year); generally considered good for growth. |
| Walking | Moderate (3–10%); a warning signal for the economy. |
| Galloping | Very high, double or triple digit; damaging to the economy. |
| Hyperinflation | Extremely rapid and out of control (e.g., prices doubling in days). |
By Cause
- Demand-Pull Inflation — "too much money chasing too few goods." Aggregate demand exceeds aggregate supply (e.g., rising incomes, increased government spending).
- Cost-Push Inflation — arises from an increase in the cost of production (e.g., higher wages or costlier raw materials like crude oil), which producers pass on as higher prices.
Related Concepts
- Stagflation — high inflation combined with stagnant growth and high unemployment.
- Deflation — a sustained fall in the general price level.
- Disinflation — a slowdown in the rate of inflation.
- Reflation — a deliberate attempt to raise prices to counter deflation.
Measurement of Inflation in India
| Index | Full Form | Released By | Base Year |
|---|---|---|---|
| CPI | Consumer Price Index (retail) | NSO, MoSPI | 2012 |
| WPI | Wholesale Price Index | Office of Economic Adviser, DPIIT | 2011–12 |
- The CPI measures the change in retail prices faced by consumers. It has variants — CPI (Combined), CPI-Rural, CPI-Urban, and older series like CPI-IW (Industrial Workers).
- The WPI measures prices at the wholesale level and does not include services.
- Headline inflation covers all items including food and fuel, while core inflation excludes the volatile food and fuel components to reveal the underlying trend.
- The GDP deflator — the ratio of nominal GDP to real GDP — is the most comprehensive measure of inflation as it covers all goods and services produced.
Effects of Inflation
- Debtors gain, creditors lose, as loans are repaid in money of lower value.
- Fixed-income groups (pensioners, salaried workers) suffer as real incomes fall.
- It discourages savings and can distort investment decisions.
- Moderate inflation can encourage production; runaway inflation erodes confidence in the currency.
Control of Inflation
- Monetary Policy (RBI): raising the repo rate, Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), and using Open Market Operations (OMO) to reduce money supply.
- Fiscal Policy (Government): reducing public expenditure and increasing taxes to curb demand.
- Inflation Targeting: Under the amended RBI Act, India follows a flexible inflation-targeting framework with a target of 4% (+/- 2%). The Monetary Policy Committee (MPC) — a six-member body — sets the policy repo rate to achieve this target.
Prelims Pointers
- CPI is released by the NSO under MoSPI; WPI is released by the Office of the Economic Adviser (DPIIT).
- Headline inflation includes food and fuel; core inflation excludes the volatile food and fuel components.
- The Monetary Policy Committee (MPC) has six members and decides the repo rate.
- GDP deflator is the broadest measure of inflation, covering the entire economy.
Mains Angle
- Distinguish between demand-pull and cost-push inflation with examples relevant to India.
- Evaluate the effectiveness of inflation targeting as a monetary policy framework in India.
Practice this topic
Browse all Indian Economy MCQs →Ready for Mains? Write a full answer on this topic and get it graded by our AI examiner.
Write an answerRelated topics
Introduction to the Indian Economy
The structure of the Indian economy — types of economic systems, the three sectors, organised vs unorganised, and the landmark 1991 LPG reforms.
National Income Accounting (GDP, GNP, GVA)
How a nation's income is measured — GDP, GNP, NNP, NDP and GVA, the difference between nominal and real, and the three methods of measurement.
Economic Planning & NITI Aayog
Planning in India — the Planning Commission and the Five-Year Plans, the shift from imperative to indicative planning, and the creation of NITI Aayog in 2015.
Money & the Banking System
The functions of money, the measures of money supply (M0–M4), the role of the RBI, and the types of banks that make up India's banking system.