1. Definition and measurement of inflation
1.1 Inflation definitions
According to Patrick J. Welch and Gerry F. Welch (2010, p. 113), inflation occurs when there is an increase in the general level of prices. It does not mean that prices are high, but rather that they are increasing. Since inflation refers to an increase in the general level of prices, the price of every good and service need not increase. For example, if the inflation rate is 10 per cent, it means the on average the price are increasing by 10 per cent but the increase of the prices of some individual goods would probably vary. Another definition of inflation is that inflation is a process of too much money chasing too few good which is supported by the demand pull theories (Marin 1992, p. 52). There are various methods to measure the inflation of economies, below we will talked about several usual methods.
1.2 Measurement of inflation
1.2.1 Core Inflation
Core inflation in general refers to the measurement of inflation that excludes food and energy prices because these goods are considered as volatile and supply driven. Core inflation is often used as a policy variable for monetary policy because it is aligned to demand pressures yet remains an unbiased indicator of inflation (Ames 2007, p. 54). This measurement of inflation is often used by economists who want to eliminate volatility and fluctuations of inflation caused by nature causing price increases. For example, when there should be some instabilities in the middle east, usually the price of oil would increase to some extent. The removal of these uncertainties would be helpful in assisting people to measure the inflation more accurately, in particular in the year on year comparisons.
1.2.2 CPI (consumer price indices)
Consumer price indices have a long history in official statistics. They measure the erosion of living standards through price inflation and are probably the best known statistics among the media and general public. Consumer price indices measure the change in the prices of a basket of goods and services that are typically purchased by specific groups of households. For example, the index for food is intended to cover food and non-alcoholic beverages but exclude purchases in restaurants. The index for energy is intended to cover all forms of energy including fuels for motor vehicles, heating and other household uses (OECD 2005, p. 76). As we have understood, CPI is probably the most known and used index to measure the rate of inflation and that concern people a lot.
1.2.3 WPI (Wholesale Price Index)
An index that measures and tracks the changes in price of goods in the stages before the retail level. Wholesale price indexes (WPIs) report monthly to show the average price changes of goods sold in bulk, and they are a group of the indicators that follow growth in the economy (investopedia.com 2011). For example, in Japan, the domestic Wholesale Price Index covers domestically manufactured products for domestic demand, excluding those exported via the domestic market. It represents in principal the overall price fluctuations at the primary wholesalers stage including VAT (OECD 1999, p. 56).