Inflation is down but real prices are not
The Financial Express, March 20, 2009, Page 2
Inflation as measured by wholesale price index fell to a record low of 0.44% for the week ending March 7. WPI-based inflation is expected to go to the negative territory soon. So, why does it seem prices paid for many daily items are not going down? If inflation is so low, why are bank lending rates still on the higher side? And should India worry about something called deflation?
Some answers:
Why is WPI falling sharply?
WPI is measures how the index for a particular week looks vis vis what it was exactly a year back for the same week. 0.44% inflation means prices for week ending March 7 rose by only that much vis vis the March 7 week of 2008. WPI was high last year this time, so the base effect (high denominator) explains one part of the sharp fall. But more important is that inflationary forces are subsiding rapidly. The best way to see this is to look at month to month changes in prices that are adjusted for seasonal effects. By month to month data analysis, WPI is already in negative territory.
So what about consumer prices?
A: There seems to be a disjunction between inflation as measured by WPI and by consumer prices. The latest CPI (consumer price index) for industrial workers is around 9%. But CPI comes with a two month lag. So, we only have the January figure now. Also, the fall in fuel, transport costs, rents are probably working with a lag on final food and other consumer item prices. Also, sticky food prices may be a reflection of higher rural demand, influenced by public expenditure on employment creation and a few years of good harvest.
Is it deflation?
Deflation happens when demand contracts (not just slows). We are at a point when inflation may turn negative in coming weeks. But, the economy as a whole continues to grow, even though at a slower pace. Therefore, it is disinflation – negative inflation rate but over all demand not contracting – and not deflation that India is looking at.
Will lending rates come down sharply now?
Three factors are important: how sharply and how soon will the RBI cut policy rates, how and whether that will change banks’ perception of lending to business and how the RBI will manage the effect of high government borrowing, which puts upward pressure on interest rates.
The Financial Express, March 20, 2009, Page 2
Inflation as measured by wholesale price index fell to a record low of 0.44% for the week ending March 7. WPI-based inflation is expected to go to the negative territory soon. So, why does it seem prices paid for many daily items are not going down? If inflation is so low, why are bank lending rates still on the higher side? And should India worry about something called deflation?
Some answers:
Why is WPI falling sharply?
WPI is measures how the index for a particular week looks vis vis what it was exactly a year back for the same week. 0.44% inflation means prices for week ending March 7 rose by only that much vis vis the March 7 week of 2008. WPI was high last year this time, so the base effect (high denominator) explains one part of the sharp fall. But more important is that inflationary forces are subsiding rapidly. The best way to see this is to look at month to month changes in prices that are adjusted for seasonal effects. By month to month data analysis, WPI is already in negative territory.
So what about consumer prices?
A: There seems to be a disjunction between inflation as measured by WPI and by consumer prices. The latest CPI (consumer price index) for industrial workers is around 9%. But CPI comes with a two month lag. So, we only have the January figure now. Also, the fall in fuel, transport costs, rents are probably working with a lag on final food and other consumer item prices. Also, sticky food prices may be a reflection of higher rural demand, influenced by public expenditure on employment creation and a few years of good harvest.
Is it deflation?
Deflation happens when demand contracts (not just slows). We are at a point when inflation may turn negative in coming weeks. But, the economy as a whole continues to grow, even though at a slower pace. Therefore, it is disinflation – negative inflation rate but over all demand not contracting – and not deflation that India is looking at.
Will lending rates come down sharply now?
Three factors are important: how sharply and how soon will the RBI cut policy rates, how and whether that will change banks’ perception of lending to business and how the RBI will manage the effect of high government borrowing, which puts upward pressure on interest rates.
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