Before rising inflation causes the downfall of the incumbent government, let’s have a look at the Indian system of calculating inflation.

Is inflation rising because of price rise in essential commodities? Or is it because of the erroneous method of calculating inflation?

Some economists assert that India’s method of calculating inflation is wrong as there are serious flaws in the methodologies used by the government.

So how does India calculate inflation? And how is it calculated in developed countries?

• India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy.
• Most developed countries use the Consumer Price Index (CPI) to calculate inflation.

Wholesale Price Index (WPI)

WPI was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s.

WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the economy.

Consumer Price Index (CPI)

CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation.

CPI is a fixed quantity price index and considered by some a cost of living index. Under CPI, an index is scaled so that it is equal to 100 at a chosen point in time, so that all other values of the index are a percentage relative to this one.

India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for.

CPI is the official barometer of inflation in many countries such as the United States, the United Kingdom, Japan, France, Canada, Singapore and China. The governments there review the commodity basket of CPI every 4-5 years to factor in changes in consumption pattern.

WPI does not properly measure the exact price rise an end-consumer will experience because, as the same suggests, it is at the wholesale level.

he main problem with WPI calculation is that more than 100 out of the 435 commodities included in the Index have ceased to be important from the consumption point of view.

India constituted the last WPI series of commodities in 1993-94; but has not updated it till now that economists argue the Index has lost relevance and can not be the barometer to calculate inflation.

But why is India not switching over to the CPI method of calculating inflation?

Finance ministry officials point out that there are many intricate problems from shifting from WPI to CPI model.

First of all, they say, in India, there are four different types of CPI indices, and that makes switching over to the Index from WPI fairly ‘risky and unwieldy.’ The four CPI series are: CPI Industrial Workers; CPI Urban Non-Manual Employees; CPI Agricultural labourers; and CPI Rural labour.

Secondly, officials say the CPI cannot be used in India because there is too much of a lag in reporting CPI numbers. In fact, as of May 21, the latest CPI number reported is for March 2006.

The WPI is published on a weekly basis and the CPI, on a monthly basis.

And in India, inflation is calculated on a weekly basis.

The credit for this research goes to economists V Shunmugam and D G Prasad working with India’s largest commodity bourse — the Multi Commodity Exchange .

Plzz comment and discuss…

A definition of inflation can be found in Economics by Parkin and Bade:

Inflation is an upward movement in the average level of prices. Its opposite is deflation, a downward movement in the average level of prices. The boundary between inflation and deflation is price stability.

Inflation is caused by a combination of four factors:

1. The supply of money goes up.
2. The supply of other goods goes down.
3. Demand for money goes down.
4. Demand for other goods goes up.

Calculation…

The formula for calculating the Inflation Rate looks like this:

((B – A)/A)*100

So if exactly one year ago the Consumer Price Index was 178 and today the CPI is 185, then the calculations would look like this:

((185-178)/178)*100
or
(7/178)*100
or
0.0393*100

which equals 3.93% inflation over the sample year.

Consider the U.S. system…..

The Consumer Price Index (CPI-U)  is compiled by the Bureau of Labor Statistics and is based upon a 1982 Base of 100. A Consumer Price Index of 158 indicates 58% inflation since 1982, the commonly quoted inflation rate of say 3% is actually the change in the Consumer Price Index from a year earlier.

For more..keep checking the blog.

Some related links..

http://www.inflationdata.com/Inflation/

http://www.bls.gov/CPI/ /* homepage of U.S. CONSUMER PRICE INDEX */

http://en.wikipedia.org/wiki/Inflation_rate

For inflation in India wait for my next post….

Plzz comment and discuss….