Inflation is a critical measure of the economy’s health. Rising inflation not only makes products and services pricy but also pulls down the value of the domestic currency. The government keeps a close eye on domestic inflation and implement policies to keep it under manageable range. But, how to measure inflation. Consumer Price Index or CPI comes into the picture here.
Now, what is CPI?
The CPI index is a metric to quantify inflation. It is calculated by tracking the change in the prices of essential products and services consumed by households over a period of time. The consumer price index captures the inflation in a fixed set of items like transportation, food, medical care, education, etc at the retail level.
To understand CPI meaning, it is important to know the methodology behind it. The basic building block of the CPI index is a basket of goods and services. After the items in the basket are finalised, the tracking of the prices is initiated.
India is a diverse country, and due to supply-side disparities, a product’s price may see a higher rise or decline in a rural area than an urban area. For instance, suppose there is a shortage of onions in the country. The concept of demand-supply dictates the price of onions will rise by certain percentage points.
The rise in price due to low production will be the same across the country. But some far-flung rural areas may see a higher increase in price due to the inefficiency of supply chains, which get aggravated when quantities decline.
To get a balanced idea, the change in the price of the basket of goods and services is tracked at the rural, urban and pan-India level. Additionally, different products and services are assigned different weights in the basket. A product can also have different weightage at the rural and urban levels. For example, food and beverages have 54.18 percent weightage in rural CPI but carry only 36.29 percent weightage at the urban level.
It is a highly dynamic metric, and it is quite a task to calculate the consumer price index. For convenience and also for better clarity over price movements, different CPI is computed on different clusters of products.
Various series of the CPI is released. These are CPI for Industrial Workers (IW), CPI for Agricultural Labourers (AL), CPI for Rural Labourers (RL), and CPI (Urban) and CPI (Rural). The Labour Bureau compiles CPI (IW), CPI (AL) and CPI (RL), while the CPI (Urban) and CPI (Rural), which have a wider population coverage, are compiled by the CSO. These bodies are responsible for the compilation of data, but the collection of data requires extensive work. Field investigators fan to every corner of the country to collect data on price fluctuation from rural and urban areas.
The reason to calculate separate CPIs is to get clarity on the impact of inflation on different income sections. In a country like India with wide income disparity, it gives crucial insight to policymakers to measure the effects of monetary policies in common people’s lives.
What is the importance of the CPI index?
Inflation can have a wide-ranging impact on the livelihood of the people in a developing country like India. CPI is a measure of inflation at the retail level, which means it gives a clear idea of the price rise for the common citizen.
It is a crucial metric to ascertain the cost of living in the country and provides vital pointers to the policymakers. The Reserve Bank of India uses the CPI index as a major metric for the formulation of the monetary policy. The Monetary Policy Committee has set itself a target of maintaining the inflation within a band of 2 -6 percent.
The consumer price index is also used to determine the dearness allowance of government employees. It helps in understanding the real value of wages and salaries and the purchasing power of the currency.
How is CPI calculated?
Just like the Wholesale Price Index, the CPI too is calculated with reference to a base year. CPI can be easily calculated by dividing the cost of the basket of items in the current year with the price in the base year and multiplying the result with 100. The annual percentage change in CPI is used to assess inflation.