UPSC Notes / Indian Economy / Chapter 8
Chapter 8 of 15

Inflation and Monetary Policy

CPI vs WPI, causes and types of inflation, and the RBI's monetary policy tools used to keep prices within the inflation-targeting band.

📖 ~14 min read 📊 Indian Economy

Introduction

Inflation — a sustained rise in the general price level — directly affects the purchasing power of every citizen, making its measurement and management through monetary policy one of the most consequential (and heavily tested) areas of the Indian Economy syllabus.

Measuring Inflation — CPI vs WPI

IndexCompiled ByBasket FocusPolicy Use
Consumer Price Index (CPI)National Statistical Office (NSO)Retail prices of a basket of goods/services consumed by householdsRBI's official inflation target is based on CPI (combined, headline)
Wholesale Price Index (WPI)Office of Economic Adviser, Dept. for Promotion of Industry and Internal TradeWholesale prices of goods (does not include services)Used more for tracking input-cost/producer-level price trends
💡 Core Inflation: CPI excluding the volatile food and fuel components — considered a better gauge of underlying, persistent inflationary pressure since food/fuel prices swing sharply due to seasonal/global supply factors.

Types and Causes of Inflation

TypeCause
Demand-Pull InflationAggregate demand exceeds aggregate supply — "too much money chasing too few goods"
Cost-Push InflationRising production costs (wages, raw materials, energy) push up prices even without demand growth
Structural InflationBottlenecks in specific sectors (e.g., agricultural supply constraints) driving persistent price rises
Imported InflationRising global commodity prices (especially crude oil) or currency depreciation raising the cost of imports

Inflation Targeting Framework

India formally adopted Flexible Inflation Targeting (FIT) in 2016, amending the RBI Act to mandate the RBI to maintain CPI inflation at 4%, within a tolerance band of ±2% (i.e., 2-6%). The Monetary Policy Committee (MPC) is legally required to explain to the government if inflation breaches this band for three consecutive quarters.

RBI's Monetary Policy Tools

Flowchart — Monetary Policy Toolkit
Monetary Policy Instruments
↓
Repo Rate — rate at which RBI lends short-term funds to banks (primary policy rate)
Reverse Repo / SDF — rate at which RBI absorbs excess liquidity from banks
↓
CRR (Cash Reserve Ratio) — % of deposits banks must hold as reserves with RBI
SLR (Statutory Liquidity Ratio) — % of deposits banks must hold in approved liquid assets (govt securities, gold, cash)

Raising repo rate/CRR/SLR tightens liquidity and cools inflation (but can slow growth); lowering them eases liquidity and supports growth (but risks fuelling inflation) — the central trade-off of monetary policy.

📌 Current Snapshot (June 2026): The RBI's MPC kept the repo rate unchanged at 5.25% (SDF at 5.00%, MSF/Bank Rate at 5.50%), maintaining a "neutral" stance. It revised its FY27 GDP growth forecast down to 6.6% (from 6.9%) and raised its CPI inflation forecast to 5.1% (from 4.6%), citing elevated crude oil prices amid West Asia tensions and rupee depreciation. Always confirm the latest figures via the RBI's official site before the exam, as these are revised bi-monthly.
✅ UPSC Focus: CPI vs WPI — compiling body and coverage differences · Core inflation concept · Demand-pull vs cost-push distinction · Inflation targeting band (4%±2%) · Repo/Reverse Repo/CRR/SLR mechanics and their growth-inflation trade-off.

💡 Want More? Get the Full eBook

This free chapter covers the key concepts. For complete coverage with 500+ MCQs, mock tests, and previous year analysis — grab the premium eBook.

📚 Browse Premium eBooks →