Page 100 - DECO502_INDIAN_ECONOMIC_POLICY_ENGLISH

Indian Economic Policy

Notes (iii) It is historically evident that, despite intermittent deflation, the general price level has exhibited
a rising trend, and some increase in the general price level is inevitable in a dynamic and
progressive economy.
A rate of inflation higher than the desirable rate of inflation is considered to be ‘considerable’.
Now the question arises : What is the Moderate Rate of Inflation ? This question cannot be answered
in specific percentage terms because desirability of inflation depends on the need and the absorption
capacity of a country which are subject to variation from time to time. The capacity of a country to
absorb inflation may be defined in terms of the limit of the price rise beyond which the economy gets
overheated and macro variables like savings, investment, growth of output, BOP position, and
employment get adversely affected. The absorption capacity, so defined, varies from country to country
and from time to time depending on their growth potentials. Therefore, the desirable limit or the
moderate limit of inflation has to be determined for each country and for different periods of time.
There is no definite rule in this regard. However, based on the past experience, it is some times
suggested that 1-2 percent inflation in developed countries and 4-6 percent inflation in less developed
countries is the appropriate and desirable limit of moderate inflation.
As regards the desirable rate of inflation for India, the Chakravarty Committee (1985), a Committee
set up by the RBI to review the monetary system of the country, considered a 4-percent rate of inflation
in India socially desirable and conducive to economic growth. Some economists consider a lower
rate of inflation to be desirable. “Some people who regard inflation as an economic evil believe that a
price level rising at a rate of around 1.5 percent ... assists in achieving and maintaining full employment
and a satisfactory rate of growth.” However, if one goes by the recent record of inflation, inflation
rate of 1.5 percent appears to be too low to maintain “full employment and a satisfactory growth
rate.”
To conclude, a price rise of 2-3 percent per annum in the developed economy and 4-5 percent per
annum in the developing economies is generally considered as the desirable rate of inflation.
Therefore, a price rise in excess of 2-3 percent in developed countries and 4-5 percent in developing
countries can be regarded as ‘considerable’ and undesirable. This definition may not be theoretically
defendable but it is empirically defendable. Also, it has an important policy implication, i.e., so long
as (i) the general level of price rises at an annual average rate of a 2-3 percent in developed countries
and 4-5 percent in less developed countries, and (ii) macrovariables are not adversely affected by the
price rise, an anti-inflationary policy is not advisable as it may distort the price system and affect
adversely the employment and growth process.
9.2 Methods of Measuring Inflation

There are two common methods of measuring inflation : (i) percentage change in Price Index Numbers
(PIN), and (ii) change in GNP Deflator. The two methods of measuring inflation are discussed below.
Measuring Inflation by PIN
The following formula is used for measuring the rate of inflation through the change in the PIN.

PIN – PIN t–1
t
Rate of Inflation = ×100
PIN t–1
where PIN in the price index number in the year selected for measuring inflation and PIN is the
t t–1
price index number in the preceding year.
The two widely used PINs are Wholesale Price Index (WPI), also called Producer Price Index (PPI),
and Consumer Price Index (CPI). WPI is used to measure the general rate of inflation and CPI is used
to measure the change in the cost of living.
In order to illustrate the measurement of inflation, let us use price index numbers in India in the early
1990s. The WPI (1999-2000 = 100) for ‘all commodities’ increased from 134.6 in 2005-06 to 141.9 in
2006-07. The rate of inflation between 2005-06 and 2006-07 can be obtained by using the above formula
as follows.

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