We keep hearing about high inflation rates in the news all the time. But do you know how the inflation rate is calculated? Is this calculation relevant to you? Does it really measure the impact of price changes on your pocket? Let’s discuss this.
Estimated read time: 3 minutes and 07 seconds
Was this blog shared with you? You can subscribe to our personal finance newsletter to receive such insightful articles directly to your inbox!
Buckle up, here we go!
What is the inflation rate?
Inflation indicates a rise or fall in the prices of goods and services.
Let’s say you purchased 1 kg of potato at ₹20 last year. And this year the price is ₹22. So the potato price has increased by 10%, and that’s inflation.
Is inflation necessary?
Many of you would have wondered why inflation exists? Every time prices increase, the public is annoyed. Then the RBI-Government intervenes to reduce inflation. So why not just remove the inflation altogether, right?
The problem with zero inflation is that it brings zero growth along.
Just imagine if there was no increase in prices of food, fuel etc for many years? Then you won’t get any increments in your job, or you won’t be able to charge more for your products because everyone’s income hasn’t changed.
A farmer wouldn’t be able to pay more for his labours because his profit margins are the same. Also, no one will buy any land or other asset for investment because the price won’t increase. So, no real returns, right?
And if this situation continues for some time, we might see deflation and negative growth. Because people will lose interest in buying or producing things because of a lack of incentives. We wouldn’t like to be in that situation, right?
That’s why inflation should always exist to boost growth. But we should control it as hyperinflation will again cause problems.
So RBI keeps track of India’s inflation rate. In fact, they have the mandate to control the inflation rate in the range of 2 to 6%.
How is inflation rate calculated?
To measure the retail inflation rate, economists have built a basket of goods and services used by the public in their daily lives.
They give each good and service a particular weightage based on the consumer pattern. Then they add up the total prices of all goods and services present in the basket. That gives us the Consumer Price Index (CPI).
Every month, they collect prices of goods and services at the retail level to calculate the CPI. The changes in the previous CPI and the latest CPI give us the inflation rate.
As the cost of goods and services varies in urban and rural areas, we calculate both separately and combine them for the final inflation rate.
What is included in the CPI basket?
In India, the National Statistical Office (NSO) conducts the Consumption Expenditure Survey (CES) that helps us understand the consumption basket of various consumers. Suppose a consumer spends ₹20 out of ₹100 on food, then the share of food in his consumption is 20%.
Based on the previous survey, below is the weightage used for the current CPI calculation.
Check out page no.3 of this report to know more about the sub-categories.
Is the calculated inflation rate relevant today for you?
No, not much. The weightage of categories in the basket hasn’t been updated for a long time. Our consumption pattern has changed a lot in a brief time. And the Government is not able to keep up.
Also, the weightage given to all categories is very generalised. For example, if you travel a lot, then your fuel expenses would be higher than the 6.84% shown in the above table.
What if you are a vegetarian? Or spend remarkably less on clothes? Your expenses would be low, right? Also, did you know each state has a separate inflation rate too?
You can check the inflation rate of your state in the same report (Page no. 5).
So, yeah, the real inflation rate is different for everyone. The numbers published every month are often irrelevant to you if your lifestyle is different.
If you track each and every expense of yours, you can calculate your own inflation rate. This would give you a better idea of your expenses and help you improve your investment planning.
And if you fear that your inflation rate is too high, and due to market conditions, you might get affected if a recession happens. We have got you covered. Learn how to protect yourself from a recession here.
Share it with your buddies.
Still Curious?
If you are like us, who likes to analyse a little more or check out content in different formats, well you are in luck. Below you can find some suitable content we found.
Mint – CPI weights need rejig for gauging inflation better
TOI – Why India’s inflation basket need an overhaul
Wall Street Journal – How the Consumer-Price Index Measures Inflation
Note: We don’t have any affiliation with them. We are sharing links only for educational purposes. The opinions expressed by them belong solely to them and do not reflect the views of Vrid.