Context:
The Reserve Bank of India’s recent observations reveal a noteworthy shift in the dynamics of inflation in India, with supply and demand factors playing crucial roles. Over the period from January 2019 to May 2023, approximately 55% of the Consumer Price Index (CPI) headline inflation is attributed to supply-side factors, while demand drivers contributed 31%.
Relevance:
GS III: Indian Economy
Dimensions of the Article:
- Causes of Inflation in Recent Years in India
- Methodology for Assessing Inflation Causes
- Understanding Inflation: Definition and Impact
Causes of Inflation in Recent Years in India
Impact of Covid-19 Waves:
- Supply disruptions during both Covid-19 waves were the primary contributors to inflation.
- Pandemic-induced lockdowns led to a significant drop in production and demand, causing a sharp decline in economic growth.
- Weakened demand during this phase also led to a reduction in commodity prices.
Reopening Challenges:
- The reopening of the economy, coupled with vaccine distribution and pent-up demand release, resulted in a faster recovery of demand compared to supply.
- This imbalance exerted upward pressure on commodity prices.
- The Russia-Ukraine conflict in 2022 intensified supply chain challenges, compounding commodity price pressures.
Methodology for Assessing Inflation Causes
Monthly Shifts in Prices and Quantities:
- Inflation’s nature is determined by unforeseen shifts in prices and quantities within a month.
- Demand-driven inflation occurs when prices and quantities move in the same direction, while supply-driven inflation sees prices and quantities moving in opposite directions.
Supply-Driven Inflation Indicators:
- Unexpected changes in prices and quantities moving in opposite directions indicate supply-driven inflation.
- A decrease in supply linked with a lower volume but increased prices, and vice versa, characterizes supply-driven inflation.
Combining Demand and Supply Factors:
- Assessing overall headline inflation involves combining demand and supply factors at the sub-group level using CPI weights.
Headline Inflation Measurement:
- Headline inflation is a comprehensive measure of total inflation within an economy, encompassing volatile commodities like food and energy.
- Calculated through the Consumer Price Index (CPI), it determines inflation by assessing the cost of purchasing a fixed basket of goods.
Understanding Inflation: Definition and Impact
Definition of Inflation:
- Inflation, according to the International Monetary Fund, is the rate of increase in prices over a specified period, encompassing a broad measure of overall price increases or specific goods and services.
- It signifies the rising cost of living, indicating the increase in the expense of a set of goods and/or services over a defined period, typically a year.
Impact of Inflation in India:
- In India, the impact of inflation is particularly significant, given economic disparities and a large population.
Causes of Inflation:
- Demand-Pull Inflation:
- Occurs when the demand for goods and services surpasses their supply.
- High overall demand in the economy prompts consumers to pay more for available goods and services, resulting in a general price increase.
- A booming economy with substantial consumer spending can create excess demand, exerting upward pressure on prices.
- Cost-Push Inflation:
- Driven by an increase in the production costs for goods and services.
- Factors such as increased incomes, rising costs of raw materials, or disruptions in the supply chain contribute to this type of inflation.
- Built-In or Wage-Price Inflation:
- Described as a feedback loop between wages and prices.
- When workers demand higher wages, businesses may raise prices to cover increased labor costs.
- Collective bargaining by labor unions can lead to higher wages, escalating production costs and subsequently causing higher prices for goods and services.
-Source: The Hindu
