Between WPI and CPI, which is the better indicator of inflation ?
Inflation is one of the most important macroeconomic indicators assuming profound importance in the conduct of monetary policy, measuring the cost of living, indexing the wages and other debt obligations, understanding the change in consumption pattern of different groups of consumers etc. Hence, the best indicator must be one which accurately and adequately reflects the change in prices. In this respect, the index most appropriate as an indicator of inflation is GDP deflator, because it encompasses the entire spectrum of economic activities. But it has very limited use in the conduct of monetary policy as it is available at a frequency of twelve months with a lag of around two years. However, it is difficult to evaluate the relative importance of a particular measure since it depends upon the purpose for which it has been used and the frequency at which it is available. WPI is available on weekly basis and CPI is available on monthly basis. These two measures assume importance in their respectiveapplications. For instance, WPI is used as an indicator in the conduct of monetary policy whereas CPI reflects changes in the retail prices of a basket of commodities consumed by a homogeneous group of consumers. Thus, CPI is more useful in capturing the consumption pattern of different segments of the population and accounting the cost of living.

If world over CPI is used then why is WPI given so much importance in India, making Indian inflation rate incomparable with the world rate?
There are arguments in favour of CPI for inflation targeting. However, use of CPI as an indicator or as a target variable is not free from caveats. The central banks, which adopt CPI as a target variable, are bound to avoid commodities whose prices are subject to sharp fluctuations due to frequent supply shocks. CPI is suffering from some inherent measurement bias such as arbitrary weighting schemes, sampling techniques and quality adjustments etc. Moreover, the very constructs of CPI for different groups of homogeneous consumers assume the specific importance of understanding the cost of living, and changing consumption pattern. Hence, WPI is given more importance in the conduct of monetary policy. However, in the wake of financial liberalisation, a comparable price index is very essential.

Is there a direct relationship between money supply and inflation? If yes then how is it that in India if money supply rises inflation falls?
There is no one-to-one correspondence between money supply and inflation in India. This is because inflation is mostly tracked by the rise in agricultural prices - particularly by food grain prices, which is in turn determined by the operation of the public distribution system and change in the administered prices. Hence, monetary policy has very limited scope to control inflation. Moreover, what is relevant to monetary policy is the core inflation. WPI measures the headline inflation, which is suffering from frequent transitions. The inverse relationship between money supply and inflation, which has been persistent in recent times, has a different explanation. As we move from the repressed financial system to a more marketed oriented one the money supply tends to become more endogenous.

When the economy is in transition, uncertainty builds up in the financial market, causing rise in demand for money as a residual asset and leaving the aggregate demand unaffected. This is evident if we look at the sharp rise in the income velocity of money during the low inflation period. Hence, low inflation must be attributed to industrial recession and sufficient food grain production.

Why is it that during elections or budget announcements, inflation is usually low?
This is the basic hypothesis of the political business cycle theory, according to which the politicians try to keep the inflation at the optimal level during election by restrained policy measures. The Indian experience also holds this hypothesis. Studies indicate that in the election year the policy seems to be expansionary, but price reduction is achieved by releasing food grains through Public Distribution system, since the overall prices in India are mostly influenced by food grain prices. However, inflation builds up immediately after the election due to politically motivated government expenditure.

Is inflation in your opinion calculated accurately or is it manipulated to reduce financial pressures/expenditures?
Underestimating the true inflation may not help much in keeping down the financial pressure because it depends upon the extent to which the government debt obligations are price indexed. Moreover, whether inflation is free from measurement bias or not inflationary impact on government expenditure is inevitable, since the government is concerned with real expenditure and most of the expenditures are obligatory in nature. Hence, the fiscal authority has limited scope for cutting down real expenditure.

Experience shows that expenditure adjusts much faster than the revenue to inflation. Hence, inflation expands the deficit and government expenditure further. Therefore, mere measurement manipulation will not help in the real sense to reduce the financial pressures.

Is inflation regarded as a growth indicator i.e. low inflation means depressed growth and high inflation means rapid growth?
There is no harm in using inflation as an indicator of growth so long as inflation and growth move in tandem or the relationship between these two is innocuous. In contrast, if inflation has a harmful impact on productivity and efficiency and its volatility provides scope for distorting resource allocation and long term contracts then it can only adversely affect growth. This will result in persistent high inflation and low growth - a situation we had in the 1970s. Indeed, there is a threshold rate of inflation given the structure of the economy. If inflation rate breaches this threshold rate then it begins to erode economic growth. So long as money is non-neutral and output inflation trade-off persists, it is dangerous to use growth and inflation interchangeably. Hence, the persistence of low industrial growth associated with low inflation in recent times should not be taken for granted to presume that higher inflation indicates higher growth.

With government cutting down its expenditure by reducing subsidies and adopting harsh monetary policies what will be the impact on inflation?
Apparently tight monetary policy seems to bring down the inflation whereas cut in subsidies feeds inflation. However, in the Indian context, harsh monetary policy has less scope to control inflation because the overall rise in prices is due to increase in agricultural prices, which is in turn determined by procurement / minimum support prices and issue prices of food grains.

Harsh monetary policy generally slows down the nominal demand for industrial output and causes fall in industrial prices, which in turn moderates the overall inflation.

However, the impact of demand shocks on inflation depends upon how producers perceive the nominal shock to demand i.e. whether it is transient or permanent. Normally, when the economy is in slow growth path, the producers tend to believe that it would be permanent and therefore, they cut down production rather than the prices. In addition, the alarming growth of fiscal deficit begs the central question of whether it is possible for the RBI to go for a restrictive monetary policy.

The recent trends show that if the government debt market is not supported by sufficient liquidity in the market, then it becomes the responsibility of the RBI to accommodate the government debt by devolvement/private placement, which leads to automatic monetisation of the government deficit.

This argument suggests that RBI autonomy is an inevitable precondition. Hence, a package of measures is very important to achieve fiscal discipline rather than just cutting down on subsidies.

After remaining stable for a couple of weeks at around 3-3.5 per cent, inflation is now on the rise, taking into account diesel, petrol and LPG price hikes. Where will this level settle?
It is very difficult to foresee what will be the impact of increase in the administered prices on inflation over a period of time, because it is one short rise producing a bubble in the prices for the time being. However, it definitely feeds into inflation with a time lag, but may not be reflected by rate of change in prices.

What is the right level of inflation that India can digest if it has to attain a 8 per cent growth?
The output-inflation trade-off is specific to the country and the structure of the economy. However, there is a threshold rate, generally pegged at 6 to 7 per cent for India.

If inflation exceeds or falls below the threshold rate then it can have an adverse impact on real growth. Empirical studies indicate that if the inflation rate exceeds the threshold rate of 6 per cent then output falls by slightly less than half a per cent.

Will the revamped inflation index help give us a more realistic picture of the actual level in the economy?
The recent Working Group under the chairmanship of Y K Alagh in 1993 and now under S R Hasim paid more attention to reviewing the commodity basket of the current series and determining suitable weights for the revised baskets of commodities in the construction of WPI.

This has the advantage of its availability at high frequency. But it is certainly an inadequate measure of inflation. For, it ignores the non-commodity producing sectors and this is a limitation.