Explained: What is inflation and how is it measured?

The gradual increase in the cost of goods and services is known as inflation. A nation's economy is in danger when inflationary forces are present, but deflation, also known as negative inflation is a much more dangerous problem. 

The gradual increase in the cost of goods and services is known as inflation. A nation's economy is in danger when inflationary forces are present, but deflation, also known as negative inflation is a much more dangerous problem. 

Price indices are used in India to calculate inflation and deflation by tracking changes in the cost of goods and services. The increase in the cost of food, petrol, and other items is taken into account when calculating the headline inflation rate, sometimes referred to as overall inflation. 

Too-low inflation can also impede growth by keeping too much money in savings accounts, as people hold off on spending while they wait for the value of their money to increase, just as high inflation can suffocate the economy by diminishing purchasing power. 

The ideal inflation rate encourages people to spend money now rather than store it for the future, which leads to the correct kind of economic growth. 

India uses both the Consumer Price Index (CPI) and the Wholesale Price Index (WPI) to measure inflation. 

Wholesale Price Index (WPI) 

 WPI, as its name suggests, measures wholesale prices, and the Reserve Bank of India utilized it until 2014 to determine monetary policy. The cost of a typical basket of wholesale goods is what is known as the wholesale pricing index (WPI). It illustrates the overall expenditures after taking a basket of 697 items into account. 

The WPI basket is made up of Manufactured Goods (65 per cent of the total weight), Primary Goods (20.1 per cent), and Fuel and Power (5 per cent of the total weight) (14.9 per cent). The WPI is calculated by the Ministry of Commerce and Industry. 

Under former governor Raghuram Rajan, the RBI switched to the Consumer Price Index because it overlooks services and bottlenecks between wholesalers and retailers. 

Consumer Price Index (CPI) 

The CPI is a measure of changes in retail prices based on 260 commodities, some of which include services. The Ministry of Statistics and Programme Implementation regularly gathers pricing for representative goods and services (usually once per month) and keeps track of any changes. 

A base year is used to compare rate measures. In the specified time frame, this might be regarded as the "first" year. Prices in the base year are usually set to be 100 to simplify calculations. 

The Consumer Price Index is calculated by using the following formula: 

CPI =( Cost of Basket at current prices /Cost of Basket at base prices )x 100