The difficulty of understanding inflation and how it's measured

Recent criticism of the GDP deflator used for India's output data was too unconvincing to make us revise our methodology

- T.C.A. ANANT

A recent column by a former chief economic advisor of India highlights the difficulty some economists face in understanding data. To explain this, let us revisit some basic concepts. All of us are familiar with the basic concept of inflation, which refers to the rate of increase in prices over a defined term period.

The measurement of inflation can be broad or narrow, depending on the range of goods and services covered, or the region for which the measurement is done. In macroeconomic analysis, we typically refer to a broad measure corresponding to the price level associated with the aggregate of all goods and services produced in the economy. In line with this broad understanding, we have measures like the Consumer Price Index (CPI) which includes prices of goods and services consumed by the representative consumer, the Producer Price Index (PPI) which captures prices received by producers of goods and services, and the implicit deflator in national-accounts computations which reflects the ratio of nominal and real GDP. Such concepts have been implemented in most major economies. As is the case in all empirical measurements, different measures exhibit different behaviours. A data blog by the Federal Reserve of St Louis captures this phenomenon well (bit.ly/3tjoY4H).