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A rise in the general level of prices;1 a sustained rise in the general level of prices;2 persistent increases in the general level of prices;3 an increase in the general level of prices in an economy that is sustained over time;4 rising prices across the board5—is inflation. These are some of the most common academic definitions of inflation. If the price of one good has gone up, it is not inflation; it is inflation only if the prices of most goods have gone up.6
When the general level of prices is falling over a period of time this is deflation, the opposite situation of inflation. It is also known as disinflation. But in contemporary economics, deflation or disinflation not used to indicate fall in prices. Instead, a price rise is termed a ‘rise in inflation’ and a price fall is termed a ‘fall in inflation’. The terms deflation or disinflation have become part of the macroeconomic policy of modern governments. In policy terms, deflation or disinflation means a reduction in the level of national income and output, usually accompanied by a fall in the general price level. Such a policy is often deliberately brought about by the governments with the objective of reducing inflation and improving the balance of payments (BoP) by reducing import demand. As instruments of deflation, the policy includes fiscal measures (as for example, tax increase) or monetary measures (as for example, increase in interest rate).
The rate of inflation is measured on the basis of price indices which are of two kinds—Wholesale Price Index (WPI) and Consumer Price Index (CPI). A price index is a measure of the average level of prices, which means that it
does not show the exact price rise or fall of a single good. The rate of inflation is the rate of change of general price level which is measured as follows:
Rate of inflation (year x) = Price level (year x) –Price level (year x-1) / Price level (year x-1)×100
This rate shows up in percentage form (%), though inflation is also shown in numbers, i.e., digits. A price index is a weighted average of the prices of a number of goods and services. In the index the total weight is taken as 100 at a particular year of the past (the base year), this when compared to the current year shows a rise or fall in the prices of current year, there is a rise or fall in the ‘100’ in comparison to the base year—and this inflation is measured in digits.
Inflation is measured ‘point-to-point’. It means that the reference dates for the annual inflation is January 1 to January 1 of two consecutive years (not for January 1 to December 31 of the concerned year). Similarly, the weekly rate of inflation is the change in one week reference being the two consecutive last days of the week (i.e., 5 p.m. of two Fridays in India).