Short note: Inflation and CPI

Inflation is a sustained increase in the general level of prices of goods and services in an economy, which reduces the purchasing power of money. If the inflation rate is f per year, an item costing C today costs C(1 + f)^n after n years.

Causes

• Demand-pull: too much money chasing too few goods.
• Cost-push: rises in wages, fuel, raw material and import prices.
• Increase in money supply, exchange-rate depreciation and supply shortages. In Nepal, prices are strongly affected by Indian prices because of the open border and the peg of the Nepali rupee to the Indian rupee.

Effects

Falling purchasing power of savings, higher interest rates, rising project costs, redistribution of wealth between debtors and creditors, and uncertain long-term planning. In economic analysis, cash flows must be adjusted using actual or constant dollars.

Consumer Price Index (CPI)

CPI measures the change in the cost of a fixed basket of goods and services bought by a typical household (food, housing, clothing, transport, health and so on), compared with a base year.

CPI (year n) = (Cost of the basket in year n / Cost of the basket in base year) × 100
Inflation rate f = (CPI_n − CPI_(n−1)) / CPI_(n−1)

Example: if the basket cost Rs 10,000 in the base year and costs Rs 12,500 now, CPI = 125, a 25% rise over the period. In Nepal, the Nepal Rastra Bank compiles and publishes the national CPI and the inflation rate, which are used to judge price changes and to convert cash flows between actual and constant dollars.