A spectre is haunting the world — the spectre of inflation. All the powers of the old World have entered into a holy alliance to exorcise this spectre: Politicians and Central Bankers, Economists and Political pundits, Households and Firms. Everyone! 

In a political-economic landscape, Inflation grips our heads as it grips the headlines! (and of course, shrinks my potato chips packet.). As Paul Krugman writes, “Inflation is an emotional subject. No other topic I write about generates as much hate mail (as inflation).” 

Inflation is inferred typically as ‘prices on the rise’; news often mentions a ‘headline’ inflation. However, a more fine understanding of inflation, reveals its inherent complexities ranging from its origin to measurement, and its notoriety in plunging states to instability. 

What is Inflation?  Inflation is the broad (average) increase in the price levels of an economy. It reduces the purchasing power thus eating away your savings. Inflation in one sector can easily leap into another sector, it can spiral, it can get high or fall low like an acrobat.

Giving shape to a ghost: How do we measure inflation?

Newsrooms are bewitched by a measure of inflation called CPI.  The Consumer Price Index (CPI) is measured by changes in the prices of a basket. (What is a consumer basket?  A consumer basket represents various household items, weighted by their relative consumer spending patterns as determined in a consumption expenditure survey. For example, in India, food and beverages are weighted at 45.86 in CPI while clothing and footwear are given a weight of just 6.53 (combined) of consumer goods and services over time. There are many measures of CPI itself: Core CPI is a CPI calculated by excluding the volatile items (Food and Fuel), and Chained CPI is meant to reflect how consumers alter their buying patterns in response to changes in relative prices

Then there are other measures of inflation – Consumer Food Price Index (CFPI), Producers Price Index (PPI), Personal Consumption Expenditure Deflator (PCE), GDP Deflator (calculates the overall inflation rate for a country), Wholesale Price Index (WPI). 

In the euro area, consumer price inflation is measured by the Harmonised Index of Consumer Prices or HICP. The term “harmonised” denotes that all the countries in the EU follow the same methodology. As methodologies improve over time, historical price indexes must be adjusted to ensure consistency. The US Bureau of Labor Statistics (BLS) utilizes a measure called the Consumer Price Index retroactive series using current methods (R-CPI-U-RS) to re-estimate the CPI-U (Consumer Price Index for All Urban Consumers) based on changing methods. This adjustment helps to account for any errors or inconsistencies that may have arisen in the original CPI-U calculations. 

In India, the widely used measures of inflation are – CPI (Industrial Workers) and CPI (Agricultural/Rural Labourers) along with WPI (which analyzes the inflation of only goods across 697 commodities).

Do these measures give the same rate of inflation? The simple answer is No. For instance, ‘CPI sources data from consumers and PCE sources data from businesses’. The distinction may seem simple; However, PCE keeps track of indirect consumer expenditures like employer-provided Medicare etc too, making it more extensive. Since, methods and data collected across the measures, vary, different measures of inflation provide a different value. Paul Krugman writes, “Discussions on inflation can be numbingly arcane – are you a core CPI type or a trimmed-mean PCE person?” (Herald-Tribune, 2006).


Scavenging this discussion, the CPI is a proxy (not absolute) measure of the cost of living and unlike CPI, the WPI basket excludes major services like trade, financing, insurance, real estate etc. in India.

Of all items, Food and beverage is the highest-weighted item (45. 86) in India’s CPI; while in the advanced economies such as the US, food is given a weight of only 13.436, in the UK 9.3 and in Germany 8.5. Thus, climatic variability like uneven rainfall can put upward inflationary pressure, making policy measures challenging in India. Perishables like Onions follow a ‘price production cobweb’ within the index. Low prices in one season force farmers to move to the cultivation of other crops in the next season. Lo and behold, demand and supply and prices drive up in the next season! 

ICRIER’s policy brief, ‘Taming Inflation’ reports the following – 

“Higher the weightage of food in overall CPI, the more cumbersome it is for monetary policy to contain inflation, as is the case in India. Importantly, the structure of headline inflation in India is quite different from the advanced economies which limits the efficacy of monetary policy in India. This corroborates the urgency to revise CPI with the latest consumption survey weights.”

Despite their deficiency, CPI and WPI are widely used measures of inflation in India.

Multiple international organisations, Labour Bureaus, and ministries provide data on a wide variety of inflation measures, unadjusted or seasonally adjusted ( Seasonal adjustment means the adjustment process quantifies seasonal patterns and then factors them out of the series to permit analysis of non-seasonal price movements) across the cross-section of the population. A wide literature exists on the methodology of CPI (see reference) and any further discussion deviates us from our agenda to catch and interrogate the culprit – Inflation.

Origin – The Inflation Theories

Someone wrote jokingly  ‘The price of grapes went up due to a raisin demand.’ which reflects one cause for inflation known as demand-pull inflation. A historical example of such inflation is the inflation spike of 1946-48 in the US. Consumers were flushed with cash from wartime savings. There was a lot of demand, especially for durables after years of wartime rationing and the economy had not reached its peacetime production. Result: Inflation peaked at 20% with high inflation continuing for 2 years. Eerily, similar one intriguing feature of the pandemic has been a behavioural shift in consumer spending. In a short period, demand for goods, especially durables increased and demand for contact-intensive services dropped. For example, the sale of used cars boomed in the US in 2020. One connected aspect can be supply-side issues.

Supply-chain bottlenecks can also be drivers of inflation. The Pandemic opened, with a thud, gates of discussion about a crisis that none of us talked about before. Let’s talk about one facet of this discussion-

See the Sea: More than 80% of merchandise trade by volume and 70% by value is carried by global maritime fleets. One measure to assess it is to ask ‘How long does it take to ship goods by sea?’ 

Two important trade lanes are – Asia-Europe and Asia-North America. 

IMF Working paper “Supply Chains and Port Congestion Around the World” provides the following insights – 

  • As the COVID crisis hit, shipping timing increased by 25% with a significant geographical variation.  
  • All congestion cannot be attributable to a sudden demand surge.  Many ports, especially since mid-2021, exhibit longer wait times despite handling less cargo than pre-pandemic. Infrastructural constraints, backlogs from current or past covid restrictions and labour shortages can be the binding factors. 

With rebounded demand, and increased input costs for firms, prices rise. This is many-a-times mentioned as Cost-push inflation in economic literature.

An early explanation of why inflation occurs in economics is what is called the Quantity Theory of money. It states that as the money supply increases, the price level in an economy increases. It can be explained by a simple Fisher equation: M*V = P*Y; Where; M stands for Money Supply; V stands for Income Velocity of money; P indicates price levels and Y represents the output levels in an economy.

Keeping V (due to institutional factors) and Y constant, one can see a one-for-one increase in prices as the money supply increases. Despite criticism by Keynesian economists and monetarists, it provides a useful intuitive idea: easy money causes inflation.

Unrestrained fiscal stimulus packages by the governments across economies during the pandemic along with expansionary monetary policies might be causing ‘persistent’ inflationary pressures. (We are talking about fiscal stimulus packages that ran into trillions of dollars!) 

Aggregate demand surged post-pandemic due to a rundown of savings by households (that includes transfer payments by the government) leading to stronger-than-expected economic recovery.

The current rental hikes in India, often known as rent inflation can be explained by so. The excessive money printing by the central bank during the pandemic ended with Venture Capitalists (VCs) between 2020 and early 2022. Many VC-backed startups in cities like Bengaluru saw a salary hike. This hike chased houses, driving up prices outrageously. (The Economic Times, 2023)

Economists are playing a tug-of-war about the nature of the present inflation; with teams divided into Team Transitory, sided by economists like Paul Krugman and Team Persistent, with economists like Larry Summers and Olivier Blanchard. To understand this, it is imperative to draw attention towards the concept of ‘Expectations’.

Great ‘Expectations’ turns out to be a problem: “Inflation feeds in part on itself” as Former Fed Chairman Paul Volcker put it at the height of Great Inflation (US) in 1979. Expectations mean the ‘belief’ that people have about future inflation, but How does it matter? As inflation persists, the purchasing power of workers erodes. If they expect higher inflation in future, they would negotiate a higher wage in the labour contract and soon this rise in wage will spiral into prices as businesses pass the increase in wages to consumers and prices rise in an economy. This situation is often known as a wage-price spiral. A classic example of such wage-price leapfrogging was in the US in the 1970s. Back then, when wage contracts came up for renewal, workers demanded big raises, both to catch up with past inflation and to offset expected future inflation.  Whenever companies changed their prices, they raised them by a lot, both to catch up with past wage increases and to offset future increases. The result: inflation became a self-fulfilling prophecy. Ending the self-sustaining process proved very difficult.

Rational Inattention 

A concept proposed by Christopher A. Sims, states that economic decision-makers selectively process information, due to limitations in absorbing all available data. When inflation is persistently high, households and businesses must pay close attention and incorporate inflation into their economic decisions. When inflation is low and stable, they are freer to focus their attention elsewhere. Attention could be bad. Longer bouts of inflation may make expectations entrenched and this poses serious risks. This can make inflation persistent and not a transitory phenomenon. Thus, the essential task of central banks is to keep inflation expectations anchored. 

RBI releases a bi-monthly Consumer Confidence Survey, releasing data on the current perception and future expectations. As of May 2023, sentiments regarding future expectations about price level are negative but showing signs of improvement.

There is even a new term, ‘Greedflation’ that is catching waves across the Atlantic. A theory/concept that inflation is being caused by corporate ‘greed’ for higher profits!

In the next act, we’ll tackle our anti-hero. We’ll introduce you to a suave character whose job is to fight inflation. Till then, Can you guess who it might be?


    1. European Central Bank; What is inflation? 
    2. Labour Bureau, Ministry of Labour and Employment; Consumer Price Index R-CPI-U-RS Homepage: U.S. Bureau of Labor Statistics
    3. Ministry of Statistics and Programme Implementation; Press Release, May 2023
    4. Pew Research Center; As Inflation Soars, a Look at What’s inside consumer price Index? pewresearchCPI 
    5. IMF; Consumer Price Index Manual – Concepts and Methods, 2020
    6. IMF, Analytical Corner, Spring Meetings 2022 via youtube Not So Smooth Sailing: Port Congestion Around the World 
    7. Times of India; Why India’s inflation basket needs an overhauling? Oct 2022
    8. US BLS, Press Release, June 2023
    9. ICRIER’s policy brief: ‘Taming Inflation’, September 2022 Taming Inflation
    10. Board of Governors. FRB, Monetary and Price Stability, August 2022
    11. The Herald-Tribune; Inflation fears are Overstated by Paul Krugman, June 17, 2006,
    12. RBI, Consumer Confidence Survey, June 2023
    13. Forbes Advisor; What are Inflation Expectations? And Why Do They Matter Now?
    14. The Economist: Greedflation is a nonsense idea
    15. O. Blanchard, Macroeconomics 4th edition, Chapter 24-25
    16. Komaromi, Andras, et al. “Supply Chains and Port Congestion Around the World.” IMF, 2022.

Khushi Bhansali

[email protected]

B.A. (Hons) Economics

Hansraj College, D.U.