The magic of Inflation

Business Standard reported, “Inflation based on the Wholesale Price Index (WPI) dropped to 3.79% for the week ended August 25 from 3.94% in the previous week. Inflation close to 7% few months back to 3.79% is more welcomed than ever. As one won’t be having any doubts regarding the importance of inflation to an economy and how it affects the economy, let’s see how it is calculated in India.

But before that, there are two methods to calculate inflation rate; Wholesale Price Index (WPI, introduced in 1902) and Consumer Price Index (CPI, introduced in the 1970s). In WPI, the calculation of inflation is done on the basis of the average rate of change in prices of a set of commodities in the wholesale market. Where as CPI is a statistical time-series value based on the weighted average of rate of change in prices of a set of goods and services purchased by consumers. Thus the CPI is much more comprehensive and it catches the inflation value from the end-consumer's side rather than from the wholesale seller's side. CPI is published on a monthly basis while WPI is available every week and has the shortest possible time lag of 2 weeks. India uses WPI while most of the developed countries use CPI to calculate the inflation rate.

The prices of a set of 435 commodities (such as onion, rice, dal etc.) are used for calculating WPI in India. Economists say that India should adopt CPI for inflation calculation as it is the one that shows price rise an end-consumer would experience. Finance Ministry counters it saying that in India there are 4 CPI indices (CPI Industrial Workers, CPI Urban Non-manual Employees, CPI Agricultural Labourers and CPI Rural Labour) in existence which makes switching over to CPI riskier and complex and also CPI has too much lag time in reporting. But then, the question remains how the United States, the United Kingdom, Japan, France, Canada, Singapore and China use CPI for inflation calculation?

The way in which WPI inflation rate is calculated in India can be found out in the article, How is WPI inflation rate calculated in India?.

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