Inflation

Also called: Rising prices · Topic: Inflation and Index Numbers: CPI, WPI, IIP and the Deflator · NCERT: Class 9, Ch 8 "Building Blocks in Economics: The Problem of Choice"; Class 11, Ch 3 "Liberalisation, Privatisation and Globalisation: An Appraisal"; Class 11, Ch 1 "Introduction (Statistics for Economics)"; Class 11, Ch 7 "Index Numbers"; Class 12, Ch 1 "Introduction (Macroeconomics)"; Class 12, Ch 4 "Determination of Income and Employment"; Class 12, Ch 5 "Government Budget and the Economy"

Meaning

Inflation is a continuing rise in the general price level, meaning the prices of most goods and services, not just one item. It lowers the purchasing power of money, which is the amount of goods that one rupee can buy.

Inflation matters because it changes the real value of wages, savings, loans and welfare benefits. In India, the RBI's monetary policy is built around a CPI inflation target.

Year-on-year (y-o-y) inflation rate (%) = (Iₜ − Iₜ₋₁₂) / Iₜ₋₁₂ × 100

• Iₜ is the price index for this month.
• Iₜ₋₁₂ is the index for the same month last year.
• MoSPI uses this formula for CPI inflation (2026) [2].

Explanation

How inflation works and why it happens

• "General" means the rise covers most goods and services. "Continuing" means it lasts. A one-time jump is not inflation.
• Loss of purchasing power: suppose a basket of goods costs ₹100 this year and ₹110 next year. The same ₹100 will then buy only about 91% of the basket (100/110).
• When inflation gets very high, money stops working well (NCERT Class 11, Index Numbers):
• Money stops being a good medium of exchange (something people accept in payment). Sellers do not want money that loses value quickly.

• Money stops being a good unit of account (the measure used to state prices and keep accounts). Prices change too fast to compare.

• Demand-pull inflation (excess demand):

• Total demand is greater than what the economy can produce.
• One example is the government spending borrowed or newly created money (deficit financing) when factories cannot produce more.

• Too much money then chases too few goods, so prices rise (NCERT Class 12).

• Cost-push inflation:

• The costs of production go up, such as wages, fuel or raw materials.

• Firms pass these costs on as higher prices.

• Money supply and prices: NCERT uses these two as an example of correlation, meaning they move together. A correlation does not by itself prove that one causes the other.

Measuring the rate: price index and the base effect

• Price index: one number that shows how the prices of a fixed basket have changed since a base year. The index is set to 100 in the base year.
• Worked example (y-o-y rate): CPI in June 2025 = 105 and CPI in June 2024 = 100. Inflation = (105 − 100)/100 × 100 = 5%.
• Why compare with the same month last year? Prices move with the seasons. For example, vegetables are cheap in winter. Comparing June with June removes most of this seasonal effect.
• Base effect: the y-o-y rate depends on today's prices and on prices a year ago (the "base").
• Low base → high rate. If prices were unusually low last year, the denominator is small, so this year's rate looks large.

• High base → low rate. If prices spiked last year, the denominator is large, so this year's rate looks small, even though prices are still rising.

• RBI's method: momentum vs base effect [4]

• Momentum is the month-on-month (m-o-m) price change in the current month.
• Base effect is the m-o-m change in the same month a year ago. That change now drops out of the 12-month window.

• Change in y-o-y inflation ≈ momentum now − momentum a year ago.

• Worked example (high base):

• Index values: June 2024 = 100, July 2024 = 104 (a one-month spike), June 2025 = 105, July 2025 = 105.5.
• July 2025 inflation = (105.5 − 104)/104 × 100 ≈ 1.44%, down from 5% in June.
• Prices still rose, with momentum at +0.48%, but the +4% spike dropped out. This is a favourable base effect.
• If July 2024 had fallen to 98 instead, July 2025 inflation would be (105.5 − 98)/98 × 100 ≈ 7.65%.

Types of inflation by speed

Type	Speed	Effect
Creeping	Below about 3% a year	Generally harmless. It can even encourage firms to invest
Galloping	Double- or triple-digit rates a year (10%–999%)	People lose trust in money and move their savings into gold and land
Hyperinflation	Over 50% a month (the usual definition)	The currency is destroyed. People turn to barter or foreign currency

• How big is 50% a month? 1.5¹² ≈ 130. Prices rise about 130 times in one year, which is roughly 12,900% a year.
• Examples of hyperinflation: Germany in 1923, Zimbabwe in 2008 and Venezuela in the late 2010s. The usual cause is a government printing money to pay for large deficits while output falls.

Special kinds of price rise

• Food inflation: the y-o-y rise in food prices, measured by the CFPI (Consumer Food Price Index).
• Food prices swing a lot because supply depends on the monsoon. Heatwaves and unseasonal rain can destroy crops quickly.

• TOP (tomato, onion, potato) crops are perishable, and India has little storage for them. A small loss of supply causes a big price jump.

• Skewflation: the prices of a narrow group of goods, such as pulses or onions, rise sharply while overall inflation stays moderate. Poor households suffer more because these items take a bigger share of their budget.

• Protein inflation: the prices of pulses, milk, eggs, meat and fish rise.
• As incomes rise, people add more protein to their diet, and demand grows faster than supply.

• This makes it a structural cause, not a seasonal one.

• Shrinkflation: the pack gets smaller but the price stays the same.

• Example: a ₹10 biscuit pack goes from 100 g to 90 g, so the price per gram rises about 11%.
• The index misses this unless it compares the price per unit.

In India

• CPI (Consumer Price Index: the retail prices that households pay) is published monthly by MoSPI (Ministry of Statistics and Programme Implementation).
• WPI (Wholesale Price Index: prices in bulk trade) is published monthly by the Office of the Economic Adviser, DPIIT. NCERT gives a weekly WPI formula, but that is outdated.
• The legal base for the inflation target is Section 45ZA of the RBI Act. The Central Government, in consultation with the RBI, sets the CPI inflation target once every five years [8].
• The target notified on 5 August 2016 was 4% CPI inflation, with an upper tolerance of 6% and a lower tolerance of 2% [8].

• The same 4% (2–6%) target was kept up to March 2026. The RBI released a Discussion Paper on Review of the Monetary Policy Framework on 21 August 2025 [9].

• New CPI series (base 2024 = 100) was released on 12 February 2026, starting with January 2026 data [2][3].

• Its weights (each item's share in the basket) come from HCES 2023-24 (Household Consumption Expenditure Survey) [2].
• The number of weighted items rose from 299 to 358 [2].
• It follows COICOP 2018, a UN system for grouping household spending, so India's CPI can be compared with other countries [2].
• It uses the Jevons index (a geometric mean of price changes) at the lowest level and the Young/Modified Laspeyres index (which uses fixed base-period weights) at higher levels [2].

• Prices are collected from 1,465 rural and 1,395 urban markets in 434 towns, plus 12 online markets whose prices are collected weekly [2].

• Food weight in CPI (Combined) is falling. It was 45.86% in CPI 2012 and is 36.75% in CPI 2024 [2].

• The reason is Engel's law: as incomes rise, households spend a smaller share of their income on food.

• Latest figure: CFPI food inflation was 2.13% in January 2026 (provisional; rural 1.96%, urban 2.44%) [3].

• The RBI reads the base effect in practice:
• In May 2021, high momentum together with an unfavourable base effect pushed inflation up [4].

• In September 2024, an adverse statistical base effect plus a new rise in food prices lifted inflation again [5].

• Policy against TOP price swings: Operation Greens was announced in the Union Budget 2018-19 with ₹500 crore and is run by MoFPI (Ministry of Food Processing Industries) [6]. The MIEWS portal tracks TOP prices and sends early warnings [7].

Don't confuse with

• Disinflation: inflation slows down but prices still rise, for example from 6% to 4%. Falling inflation does not mean falling prices.
• Deflation: the price level itself falls, so the inflation rate is negative (index 100 → 98 = −2%). Deflation raises the real burden of debt and makes people put off spending, which can lead to a deflationary spiral.
• Reflation: a deliberate policy that pushes inflation and output back to normal after deflation or very low inflation. It uses rate cuts, more liquidity and more government spending.
• Base effect vs momentum: the base effect comes from last year's price level. Momentum is this month's m-o-m price change. Only momentum shows real price pressure today.

Prelims Hooks

• The y-o-y CPI inflation formula used by MoSPI is (Iₜ − Iₜ₋₁₂)/Iₜ₋₁₂ × 100 [2]. WPI is now monthly, not weekly.
• Trap: the inflation target is set by the Central Government in consultation with the RBI, not by the RBI alone. It is set under Section 45ZA of the RBI Act: 4% CPI inflation with a 2–6% band, first notified on 5 August 2016 [8].
• The new CPI has base 2024 = 100, was first released on 12 February 2026, uses HCES 2023-24 weights and has 358 weighted items [2].
• A high base lowers this year's y-o-y rate even when prices are rising. A low base raises it.
• Hyperinflation is conventionally more than 50% a month. Creeping inflation is below about 3% a year.
• Operation Greens (TOP) is run by MoFPI, not the Agriculture Ministry [6].

Mains Points

• Read the headline rate with care. A sharp fall in y-o-y CPI can come mostly from a favourable base effect while momentum is still positive. The RBI's split into momentum and base effect, as used in 2021 and 2024 [4][5], stops policy from cutting rates too early or raising them too late. This protects the credibility of the 4% (±2%) target.
• Food-heavy CPI and monetary policy. Food shocks from the monsoon, heatwaves and perishable TOP crops are supply problems that the repo rate (the rate at which the RBI lends to banks) cannot fix. The lower food weight (45.86% → 36.75%) makes CPI a better guide to demand pressure [2]. Supply-side tools such as Operation Greens, storage, cold chains and MIEWS alerts are still needed.
• Who pays for inflation. Skewflation and protein inflation hurt poor and rural households most. Shrinkflation hides real price rises. Base revisions every 3–5 years and online price collection [2] make CPI more accurate, which matters for DA, wage indexation and the real value of welfare benefits. The 2% lower band shows that the goal is moderate, stable inflation, not zero inflation.

Related concepts

• Inflation rate
• Base effect
• Food inflation
• Creeping inflation
• Galloping inflation
• Hyperinflation
• Disinflation
• Deflation
• Reflation
• Skewflation

Read more

• Measuring inflation: rate, base effect and the vocabulary of price change