The Hindu Business Line : Inflation insights

2) Last week the inflation figure was 6.02 per cent; what does it mean? Does that mean every week it is increasing? Somebody told me in Japan the inflation for that week was zero. How is it possible?

3) If I invest Rs 1,000 in a bank at, say, 6 per cent, after one year it will be Rs 1,060. Does that mean the RBI has to print Rs 60 more.

4) What is money supply and what are M1, M2 and M3.

Dipen, e-mail

Inflation, pared down to the essentials, means a rise in an index consisting of many goods that have weights attached to them. The index will always have a base year. Since the items have weights, it means that if a particular item has a higher weight and its price rises, the greater its effect on the inflation rate. At the end of the day, it depends on how much weight has been given to a particular item. Most countries use a consumer price index (CPI) while India has a wholesale price index (WPI).

As their names suggest, the CPI is a basket of items that a consumer consumes while the WPI is a basket particular to the wholesale market. Constructed with 1993-94 as the base, the WPI is made up of 435 items. These are divided in three groups, they are i) manufactured products, ii) primary products; and iii) fuel and energy, each with a weight of 63.74, 22.02, and 14.22 respectively. If you notice, the weights add up to 100.

If the inflation for a particular week is 6.02 per cent, it means that the index is 6.02 per cent higher than it was the same week the previous year. In the past decade, Japan has experienced deflation, that is, a situation where prices actually fall. Only recently has it started having low levels of inflation. Deflation occurred in Japan because a prolonged economic recession caused people to save more and spend less. This obviously led to reduced demand for goods and a consequent reduction in their prices.

If banks give 6 per cent on fixed deposits, the RBI doesn't necessarily have to print the money to account for that 6 per cent. The RBI in its normal course prints money for the smooth running of the economy, but it does not print for any one single reason. The 6 per cent interest rate will be paid by the bank lending that money out at a higher than 6 per cent.

M1 is the sum of the physical money that is held outside banks, travellers' checks and demand deposits. M2 is M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds. M3 is M2 as well as all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. M3 is referred to as broad money supply and is usually the number referred to when talking about money supply.

Sunil Rongala

Group Economist

Murugappa Group

(Send in your queries on economics to Whackonomic@gmail.com)

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