Understanding common man’s Inflation

Not long ago, we had newspaper headlines highlighting the double digit inflation figures in India and then the world went upside down when it was a hit by a financial hurricane called Sub prime crisis. Today, we are faced with the daunting task of avoiding negative inflation. So what does inflation mean to a common man like you and me and if it is going down then doesn’t it mean good news for general public because goods will become cheaper. According to economic fundas that isn’t right and lets try and figure out why.

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Inflation is generally referred as the increase in the general price level of a basket or goods and services. It’s different for different countries and for measuring India’s inflation, we have a basket of goods and services specific to India. Again, to make things more confusing for us, there are two baskets and each measure a different index termed as the Consumer Price Index (CPI) and Wholesale Price Index (WPI). The headlines that we generally see refer to the WPI. Now, WPI gives less weightage to food which is the most important price for a developing country like India. Hence you may have a scenario like today when even though, the WPI is hovering near zero, the CPI index is higher as the food prices are high. Hence, to analyse the actual increase in prices, it’s important to study the different constituents of the index you are referring to.

Also, inflation is mainly seen caused due to an increase in demand of a basket of goods and services. Hence, if demand for rice increases or the supply of rice decreases due to poor crop, bad monsoon etc, the price of rice will increase. But it’s always not true. For understanding the inflation funda, we may look at it as a case of ‘too much money chasing too few goods.’ So while there will be inflation if the demand or supply of goods fluctuate but there also will be inflation if the demand or supply of money fluctuates. For example, if the government prints more money or there is an influx of more money in market due to foreign investments, then there will be more money to buy the same quantity of rice and again that will increase the price of rice.

Coming to the next point, that if inflation signifies an increase in general price level of a good then, why is deflation considered dangerous during these times of recession, because shouldn’t I be happy that I will be able to buy goods cheaper. In this case, we have to understand that inflation is caused due to and it impacts a variety of factors and hence it is important to view inflation with respect to the nation’s economy rather than a relation between you and the good’s price. During recession, the demand of goods fall as the income levels of people fall. If the price of goods fall, it means less profit for the industry that is making the goods, lesser salaries to their employees who in turn spend lesser money in market, thus depressing many other industries and hence, a nation’s economy as a whole. This is also the reason why a developing nation like India generally has a high inflation. Because of high growth, the demand of goods among people rises as people now have more purchasing power. Also, the industries start producing more and they start borrowing huge amounts of money from banks to expand their capacity, which results in less money with the banks, technically called the credit crunch and makes an example of too less money chasing more goods causing inflation.

Thus, inflation is related to a variety of factors and while understanding the simple logic of it, let’s leave it to the economists to rack their brains about its complexities.