One of the more complex concepts in economics is inflation, even though it simply refers to an increase in prices. When we say inflation has come down from, say, 6% to 2%, it means the rate of change of prices has come down. But prices are still going up. If prices fell across the board, it would reduce the incentive of producers to produce goods and services.
The interpretation of inflation, however, has had a distinct touch of malleability. Of late, there has been a tendency to argue that inflation is up only because of certain goods and services, excluding which would make the number less bothersome.
However, the same argument is not put forth when inflation declines. A sharp fall in prices of pulses or vegetables, for example, can cool inflation. There exists a school which always argues that inflation is low; even when high, it is not a concern; and, as a corollary, interest rates should be lowered.
Let’s look at the fundamentals of monetary policy transmission. When rates are lowered, borrowings increase, leading to higher production and growth. If optimal capacity utilization is achieved, then an increase in demand leads to higher prices.
An argument is often advanced is that inflation is due to supply pressures. True, if food prices go up, it is usually because of a supply shortfall or minimum support prices hiked by the government. If fuel prices rise, then it is because fuel retailers have raised prices, usually done in response to an oil squeeze.
Even if we look at core inflation (which strips out food and fuel) or the new concept of ‘core-core’ inflation (which excludes gold too), inflation can be attributed to supply factors.
If healthcare inflation rises, it is due to higher prices charged by overloaded hospitals. When personal products get costlier, it is because companies raise prices to cover costs driven up by input scarcities.
Rarely is inflation caused solely by a demand surge, as companies plan production in line with sales projections that tend to show stable growth. Exceptions include items like semiconductors that have experienced a sudden spike in demand. Broadly, though, inflation is almost always traceable to supply constraints.
The argument that we need not bother about inflation concentrated in some products (rather than generalized inflation) is disingenuous because all product categories have different reasons for price mark-ups.
If we look at the food basket, high overall production of tur daal can drive down prices, while localized tomato crop damage can make it dearer. The latter is more perishable and that’s one among many factors that set their price dynamics apart.
Likewise, toothpaste input costs could rise while paint prices hold steady. The best we can do is track a weighted basket of items without leaving out ‘supply hit’ products.
Then there is the famous base effect, which has been cited frequently this year to justify lower interest rates. As inflation was 2.1% last year, some argue, it will not be much of a burden this year and need not be taken seriously. But when it was 2.1%, few said it was so low because of a higher rate (of 4.6%) the previous year.
Recall that when inflation reached 6.7% in 2022-23, doves argued it was a combination of the base effect and food prices that caused the upshoot, but inflation was otherwise low. To prove this, the concept of ‘momentum’ was tossed in, which simply meant looking at month-on-month change.
While there can be a debate on these issues, especially where the arguments are admittedly strong, there is also the practical reality. The consumer price index is designed to gauge inflation for consumers. So, how do they feel about it?
The Reserve Bank of India’s (RBI) inflation perception survey has interesting results. In 2025-26, when inflation officially averaged 2.1%, consumer perception placed it at 7.1%. This fiscal year, inflation has averaged 3.9% in the first quarter, but perceptual inflation was 7.7%.
So while inflation doves splice and dice their price data by removing food, fuel and gold to show that inflation is low and not a problem, the story at the household level differs. Should this matter, though, given that households could have biases created by the price escalation of items they either buy or notice more?
This leads to another point worth looking at. Companies have often said in their investor presentations that demand has been affected by inflation; that higher food bills have left less money for discretionary consumption, especially in urban areas. This is why several companies lowered the grammage of their products (‘shrinkflation’).
Even if inflation is not an issue for inflation doves, it is for companies that find their sales impacted by it. This story has been common across most consumer-facing companies since the Russia-Ukraine war began in 2022.
An interesting point concerns senior citizens. They hold almost half the term deposits at banks in India and their consumption is driven by the interest payments they receive.
For them, more than current inflation, what matters is cumulative inflation over the tenure of their deposits, as that erodes their money’s purchasing power. This was almost 19% over the four post-covid years. No wonder so many companies have been lamenting weak demand.
This returns us to the question of which inflation number policy should aim to keep stable. The regulatory target is headline retail inflation. The arguments being offered to ignore it may sound coherent, but they do not constitute a logical justification for a shift in the country’s policy approach.
These are the author’s personal views.
The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The Darker Side of the Sun’