21 February, 2020
2 Min Read
Syllabus subtopic: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.
Prelims and Mains focus: about CPI and its significance; about inflation targeting
News: The RBI governor has stressed the need to review the monetary policy framework. An inflation targeting framework is effective when the measure of inflation is accurate. But there are concerns about CPI’s composition.
What is CPI and how is it computed?
How are these weights for CPI derived?
Why is it important to update CPI weights?
As our consumption pattern shifts, a CPI based on old weights is likely to underestimate or overestimate inflation. For example, the share of expenditure on transistors, which have become obsolete, has gone down. If prices of transistors increase, old shares would give a higher inflation rate than what consumers experience.
How will this impact inflation targeting?
An inflation targeting regime is as good as the quality of inflation statistics. This is important as several other inflation indicators seem to be below 4%, even as food inflation rose, driven by onion prices. As such, we may be overestimating inflation, but there have been times when we have underestimated it. Recently, some authors argued the need to move to a broader measure of inflation target that could combine the GDP deflator, wholesale price index and CPI to avoid overdependence on a single indicator.
How do we get a right estimate of inflation?
The share of consumption expenditure has changed between the 2011 and 2017 National Accounts Statistics (NAS), with a decline in the share of expenditure on food. The official CPI series could be more sensitive to food inflation. Given that the quality and reliability of the survey data have been questioned over the years, moving towards a CPI derived from the private final consumption data from NAS must be considered.
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