[Economy] Zero Inflation: Is It Sustainable ?

Data released by the commerce and industry ministry for inflation based in WPI for November 2014, showed a new trend in Indian economy. Whereas we were weary of the rising inflation in last couple of years, the WPI data on inflation for November declined to 0.0% whereas it was 1.8% for October 2014. This phenomenon is quite talked about in the economic intelligentsia and is termed as ‘zero inflation’. Now the points of concern are:

» What does inflation means for any economy and especially for a developing economy like India?
» Is inflation in general has some optimum level for welfare of economy?
» What are the causes which lead to a situation of ‘Zero Inflation ‘?
» Zero Inflation: is it good or bad.
» What are the policy measures which need to be taken if at all needed?

INFLATION:  Inflation means a persistent rise in the prices of goods and services which reduces the purchasing power of money; particularly poor are worst hit as a greater proportion or their salary or entire salary is spent on securing basic amenities and there is little scope to cut back on savings or luxury goods, thus, they have compromise with the basic amenities such as food, clothing, etc, at times.

TYPES OF INFLATION

Depending upon the rate of growth of prices i.e. on the percentage of inflation, it is of various types.

1)    Creeping Inflation: when rate of general price increase is 1 – 5 %
2)    Trotting Inflation: when rate of increase is 5 – 10 %
3)    Galloping Inflation: when rate of increase is 10- 20 %
4)    Runaway Inflation: inflation > 20%
5)    Hyper-Inflation: inflation totally out of control

Based on the reasons of inflation, it can be of three types:

1)    Demand-Pull Inflation: inflation caused by increase in demand or when ‘too much money is chasing too few goods.

2)    Cost- Push Inflation: caused by reduction in supply, also called Supply Shock Inflation when such changes increase price rapidly.

3)    Structural Inflation: persistent inflation caused by deficiencies in structure of economy like backward agriculture

Some other reasons for inflation can be:

1)    Speculation
2)    Cartelization
3)    Hoarding

Measuring Inflation

To measure ‘general fall or rise and rate of change of prices ‘ different countries use different ways like GDP deflator, Cost of living Index, Producer price Index, Wholesale price index, Consumer price index and others. In India, to check the general trend of price levels, we use two levels: Wholesale level and Retail level. Wholesale level of prices form the Wholesale Price Index (WPI) and retail level forms Consumer price Index (CPI)

Wholesale Price Index

The Wholesale Price Index or WPI is ‘the price of a representative basket of wholesale goods’. WPI figure was released weekly on every Thursday but since 2009 it has been made monthly. The Wholesale Price Index focuses on the price of goods traded between corporations, rather than goods bought by consumers, which is measured by the Consumer Price Index. It includes 676 items that includes agricultural commodities (such as Rice, Tea, Raw Cotton), industrial commodities (such as Iron Ore, Bauxite), intermediate products for industry (such As Cotton Yarn, Iron and Steel), products for consumers (such as Atta (Wheat Flour), Sugar, Electricity, Ceiling Fans, among others) and energy items (Petrol, Kerosene). The WPI is an indicator designed to measure the changes in the price levels of commodities that flow into the wholesale trade and is very vital guide in economic analysis and policy formulation. But one of the biggest drawbacks of WPI is that it does not include services which CPI includes like transport, health, education etc.

Consumer Price Index

A Consumer Price Index or CPI measures changes in the price level of a market basket of consumer goods and services purchased by households. The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. In India, we have two CPI i.e. CPI for industrial workers (CPI-IW) and CPI for agricultural labour (CPI-AL) (third CPI Urban Non-Manual Employees, CPI-UNME was discontinued in 2008). Each track the retail prices of goods and services for specific group of people and its main purpose is to measure the impact of price rise in rural and urban poverty.

CPI gives larger weight on food items than WPI and therefore is more sensitive to changes in prices in food items whereas the change in International crude prices has greater bearing on WPI as fuel gets higher weightage in WPI.  Inflation targeting in India is done on the basis of CPI figures and further is recommended to move towards PPI figures.

Issues concerning Inflation in India

Inflation in India is quite a thing to worry not just for economists, and government but for people in general because it reduces their purchasing power. The other bad effects of inflation can be summarised as below:

(1) It can drag down growth as interest rate are raised to trap the excess money causing inflation and cost of credit increases.

(2) Low income group people are especially hurt because of high prices.

(3) Increases uncertainty and discourage investments sand saving (with increasing prices people are more inclined to spend than to save).

(4) Discourages exports as domestic sales are attractive and Balance of Payment problems can arise.

Hence altogether inflation is bad for any economy and should be under control. This gives us a hint of euphoria on reaching towards a ‘zero inflation ‘figure. But then small amount of inflation is needed for a developing economy. Small price rise is necessary for wage to go up. It also keeps the economy to stay away from the deflation which can otherwise set off a recession. Small inflation is also necessary for producers and investors which give them incentives to produce and invest. But the slight inflation should not be Structural inflation or caused due to cartelization, hoarding or speculation. It should be driven by Innovation in economy which presents new products and services thus creating new jobs and fuelling the wheels of commerce. Chakravarty committee (1985) had suggested 4% as an acceptable level of inflation on a long- term basis but has to be seen w.r.t growth rates and global levels. For RBI 5.5% inflation is considered as acceptable which does not hurt people nor hurts growth.

Reasons for Present Inflation Fall towards Zero Inflation

According to economists, the healthiest ways to keep inflation under control for India are curbing structural inflation which is created because of wrong administrative set-ups, misplaced government policies and infrastructural constraints. In India the high Inflation is often caused due to lack of storage facilities for agricultural produces, bad monsoon, rise in MSP for agro-products, non proper implementation of PDS, hoarding and cartelization which all has to be addressed through governmental interventions. But present fall in inflation can be attributed to reason below:

(1) International crude prices have fallen to half of its earlier prices. Crude oil occupies a very significant proportion of total basket of goods in the index. Hence its effect is direct and lowering of oil prices also has indirect effect on prices of other commodities in the basket. Hence the fall in crude prices is one of the most important reasons behind the ‘zero Inflation’.

(2) In CPI, food is given around 50% of the weightage which mainly contains cereals. The MSP in recent times has not been increased in cereals which has a direct effect on the prices. It indirectly leaves less money in the hands of people and also causes less demand for goods.

(3) Demand compression is further caused due to stagnant social spending like on NREGA and other schemes. Rural wages growing at lower rates, Lower agricultural growth and declining industrial production is also contributing to the Demand Compression.

(4) Tight monetary policy by RBI and no decrease in rates is further sustaining the declining inflation figures and also creating lesser demand due to lesser money in market.

(5) As claimed by some, the reason cannot be directly related to the structural improvements in economy. The new government has put in motion some reforms measures but still it is in draft phase and small measures like going strict on hoarders and cartels is insufficient to show the result we are witnessing.

Consequences of Zero Inflation

When prices come down, it’s poor who are at receiving end of benefits. There is an expectation spiral built into high inflation rate which tends to raise demands for wage. The zero inflation economy enables the authorities to reduce the price distortion; it also reduces the uncertainty involved in price drift. The zero inflation also aids in enhancing the economic growth along with adding liquid money to the economy. In such an environment the corporation is in a better position to plan for the economy and implement new rules, policies for the betterment of the economy. The government can cope better with the problems as they do not have to face the sudden shocks of supply. There is an accumulation of long-term investments as the investors are willing to invest money for a long time without any risk.

The key reasons of present decline in inflation are fall in fuel prices and food prices, which are quite volatile and subject to fluctuations and/or seasonal in nature. This kind of inflation reduction may not be sustainable and may go up again and such price changes are not within the control of monetary policy.

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