A Flawed Calculation Of Inflation

Context: The current official inflation rate does not correctly measure price rise.

Data issues in inflation measurement

• Not reflective of pandemic disruptions: The current data on prices for April to July 2021 are not comparable with the same months of 2020 because of stringent lockdown in 2020. But official inflation figures do not reflect these changes.
• Does not truly represent any category: As inflation figures are derived by assigning weights to different commodities and services and reaching an aggregate value.
  • But people are not homogenous. The consumption basket is vastly different for poor, middle classes, and rich.
  • Hence, CPI is different for each of these classes and a composite index fails to reflect true case of any category.

• Not adapting as people’s consumption basket is undergoing rapid changes: As consumer confidence fell drastically from 105 in January 2020 to 55.5 by January 2021 (RBI data), employment and incomes were still down, 230 million slipped below the poverty line.
  • Consumption basket for different sections of population had changed: While consumption pattern of well-off sections may have changed little, the poor and middle classes, especially those who lost jobs and incomes, would have had to cut back on their consumption.
  • Thus, the actual weights in CPI would have changed and inflation required recalculation, but this has not been done.
• Inflation data under-represents services in consumption basket: Services are about 55% of GDP but have no representation in WPI and about 40% in CPI.
  • During pandemic, health costs shot up and education costs soared with requirement of mobile phones, laptops and Wi-Fi, and this is not captured in inflation figures.
• Mis-correlation with other economic indicators: High inflation at time when other indicators remain constrained such as-
  • Wage loss: Due to lockdowns, wages declined, both in unorganised and organised sectors. Though the impact higher in unorganised sector with employs 94% of workforce as they have low incomes, little savings and cannot bargain for higher incomes as price rise.
  • Demand remained low: Demand has declined not only for non-essentials but even for essentials. In a vicious cycle, this is slowing down economic recovery and employment generation.
  • Cut in government expenditure: Especially on the social sector can aggravates poverty and reduces demand further.

Conclusion: Current official inflation rate does not correctly measure price rise since the lockdown administered a shock to the economy.