Inflation: how prices are measured and why they matter

Inflation is a sustained rise in the general level of prices, which reduces the purchasing power of money. A single item becoming dearer is not inflation; inflation is about the average across a broad basket of goods and services. Moderate, stable inflation is generally considered less disruptive than either very high inflation, which erodes savings and wages, or deflation, a sustained fall in prices, which can discourage spending and increase the real burden of debt.

In India, the main measure for monetary policy is the Consumer Price Index, or CPI, which tracks retail prices paid by households. The CPI combines rural and urban prices and gives substantial weight to food, which is why food price shocks are felt quickly by households and in policy debates. The Wholesale Price Index, or WPI, tracks prices at the wholesale stage and is more sensitive to manufactured goods and commodities. The two indices can move differently, so a fall in wholesale prices does not always mean relief at the shop counter.

Since 2016, India has followed a flexible inflation targeting framework. The Reserve Bank of India Act, 1934, as amended in 2016, makes price stability the primary objective of monetary policy while keeping growth in mind. The central government, in consultation with the Reserve Bank, sets the target: CPI inflation of 4 per cent, with a tolerance band of plus or minus 2 percentage points, so the range is 2 to 6 per cent. The six-member Monetary Policy Committee, with three members from the Reserve Bank and three external members appointed by the government, sets the policy repo rate to pursue that target.

Inflation affects different groups differently. People on fixed incomes, savers holding cash, and households spending a large share of income on food are hurt most by rising prices, while borrowers may gain if their incomes rise faster than interest costs. That distributional angle is why inflation is a political as well as an economic question. Analysts therefore distinguish between headline inflation, core inflation excluding volatile food and fuel, and the one-off effects of taxes, administered prices or supply shocks.