Understanding what is Retail Inflation: Every time we go shopping there always exist the killjoy comment “ When I was a kid this item used to cost only Rs. 1”. Alright, grandpa can we just buy and move on now.
Despite being a mood kill this comment has a lot of economics behind it, especially the retail inflation at play. To understand this aspect i.e. retail inflation better in this article we take a look at what is retail inflation, its affects on growth, who computes it and how?
Keep Reading to find out!
Table of Contents
What is Retail Inflation?
Retail Inflation, refers to the rate of inflation based on the Consumer Price Index (CPI), The CPI is an index that tracks the daily consumption of households and the change in the price of the goods and services these households spend on.
The CPI is also known as the market basket and this basket includes a fixed list of items which include food, clothing, housing, transportation, electronics, education, medical care etc. The prices of the fixed list of items are collected periodically.
This is done so as to compare and calculate the changes in the prices which in turn gives us an idea of the retail inflation levels in the economy. The retail inflation calculated is produced in terms of percentage. In simpler words, it computes the inflation or the deflation based on the consumers day to day living expenses.
The CPI is a macroeconomic indicator used by the government itself and several government agencies and especially the Reserve Bank of India(RBI) pay very close attention to the retail Inflation as based on the inflation levels or deflation they can take the necessary steps and produce policies to maintain price stability within the economy.
In addition to this, the CPI can also be used to compute the cost of standard living. This can be used to understand the al value of salaries, the purchasing power of the nation’s currency.
Who Calculated the Retail Inflation or Consumer Price Index in India?
In India the retail inflation is calculated by the following CPI’s:
- CPI for Industrial Workers (IW)
- CPI for Agricultural Labourers (AL)
- CPI for Rural Labourers (RL)
- CPI for Urban Non-Manual Employees (UNME)
The CPI collected by these are then further compiled and used. The Ministry of Statistics and Program Implementation collects date and compiles it from the CPI for Urban Non-Manual Employees (UNME). The CPI for Industrial Workers (IW), Agricultural Labourers (AL) and Rural Labourers (RL) are collected by the Ministry of Labour.
How is Retail Inflation or CPI Calculated?
The retail inflation or CPI is calculated by keeping a base year which is the benchmark. Any price changes are compared to this year. Then the price of the basket of a fixed list of commodities and services for this year or the year in focus is divided by the price of the basket for the base year. This is then multiplied by 100.
To put it in a formula, CPI Formula: (Price of the basket in current period / Price of the basket in base period) x 100.
How Does Inflation Affect Growth?
It goes without saying that inflation has many affects across various aspects. One of the most important being the growth of a country. But it also must be noted that just any inflation will not have negative consequences.
Hence economists have computed threshold values for inflation crossing which the growth of the economy will face negative a negative relationship. According to studies by Khan and Senhadji (2001) and Lopez-Villavicencio and Mignon (2011), these threshold tolerances vary and have different affects based on how developed the country is.
Take developing countries for example the threshold for inflation for them was pegged at 7-11% according to the studies. After which the inflation and growth relationship will be negative. Surprisingly on the other hand the threshold for developed countries lies at 1-3%.
There are also studies made specifically of India. Let’s consider the paper An Empirical Investigation by Deepak Mohanty, A B Chakraborty, Abhiman Das and Joice John (2011). This paper studies the “threshold effects” in the relationship between inflation rate and real GDP growth using data from Q1:1996-97 to Q3:2010-11.
Accordingly the study the threshold levels can be pegged at between 4-5.5%. Post this threshold the inflation has negative consequences on a country’s growth. If the inflation levels are below this level then there is a significantly positive relationship between inflation and growth.
In Closing
When it comes to inflation simply understanding it as a concept is not enough. By just doing that one may find themselves a few decades down the line stating that “This used to cost only Rs.100 in my time”.
Instead one must make an effort to consistently beat these inflation levels. Long gone are
the times of keeping deposits in banks like HDFC, Kotak etc. Today these earn a meagre 2-5% which only
results in losing the value of money he has earned.
Instead one should also look at other investment opportunities. One such opportunity to this date remains the stock market which however does require a level of self-education. These have on average returns which not only beat inflation but also provide a good enough cushion of returns. Happy Reading!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
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