Inflation is a critical economic issue that has long been a topic of concern for policymakers in India. The Reserve Bank of India (RBI) recently shed light on the changing dynamics of inflation in the country. Data from January 2019 to May 2023 reveals that about 55% of the inflation, as measured by the Consumer Price Index (CPI), is due to supply-side factors, while demand drivers account for 31%.
Causes of Recent Inflation in India
The two waves of the COVID-19 pandemic played a crucial role in triggering inflation in India through supply disruptions. The imposition of lockdowns led to a significant reduction in production and demand, which subsequently resulted in economic growth slowdown. Furthermore, commodity prices decreased due to dwindling demand. However, as the economy reopened and vaccines were distributed, demand recovered at a quicker pace than supply, resulting in increased commodity prices. The Russia-Ukraine conflict, which began in 2022, added to these pressures by intensifying global supply chain challenges.
Methodology for Assessing Inflation Causes
Inflation factors are assessed based on subsequent shifts in prices and quantities within a month. If prices and quantities move in the same direction, inflation is deemed demand-driven. Conversely, if they move in opposite directions, inflation is considered supply-driven. A rise in demand results in increased prices and quantities. Meanwhile, a decrease in supply translates into higher prices but reduced volume. To evaluate the overall headline inflation, demand and supply factors at the sub-group level were combined using CPI weights.
What is Inflation?
The International Monetary Fund defines inflation as the rate of increase in prices over a given period, either as a broad measure of overall price increases or for specific goods and services. It represents the escalating cost of living and shows how much more expensive a set of goods and/or services has become over a certain period, typically a year. In India, inflation has a particularly significant effect due to economic disparities and a large population.
Different Causes of Inflation
Demand-Pull Inflation occurs when demand for goods and services outpaces their supply. In booming economies, consumers may be willing to pay more for the available goods and services, leading to an overall increase in prices.
Cost-Push Inflation is driven by an increase in production costs for goods and services. Factors like increased incomes, elevated costs of raw materials, or supply chain disruptions can cause this type of inflation.
Built-In or Wage-Price Inflation is a form of inflation that involves a feedback loop between wages and prices. When workers demand higher wages, businesses may raise prices to cover the increased labor costs. This can make workers seek even higher wages, thus perpetuating the cycle.
UPSC Civil Services Examination Questions on Inflation
The UPSC Civil Services Examination has several previous year questions related to inflation and its causes. One of these questions for the 2021 Prelims asked about demand-pull inflation and which factors can cause or increase it. Similarly, two other questions from 2020 revolve around the weightage of food in the Consumer Price Index (CPI) and Wholesale Price Index (WPI), as well as the measures that the RBI might or might not take under an expansionist monetary policy.