Economists usually distinguish between inflation and a relative price increase. ‘Inflation’ refers to a sustained, across-the-board price increase, whereas ‘a relative price increase’ is a reference to an episodic price rise pertaining to one or a small group of commodities. This leaves a third phenomenon, namely one in which there is a price rise of one or a small group of commodities over a sustained period of time, without a traditional designation. ‘Skewflation’ is a relatively new term to describe this third category of price rise.
In India, food prices rose steadily during the last months of 2009 and the early months of 2010, even though the prices of non-food items continued to be relatively stable. As this somewhat unusual phenomenon stubbornly persisted, and policymakers conferred on how to bring it to an end, the term ‘skewflation’ made an appearance in internal documents of the Government of India, and then appeared in print in the Economic Survey 2009-10, Government of India, Ministry of Finance.
The skewedness of inflation in India in the early months of 2010 was obvious from the fact that food price inflation crossed the 20% mark in multiple months, whereas wholesale price index (WPI) inflation never once crossed 11%. It may be pointed out that the skewflation has gradually given way to a lower-grade generalized inflation, with the economy in the middle of 2011 inflating at around 9% with food and non-food price increases roughly at the same level.
Given that other nations have faced similar problems, the use of this term picked up quickly, with the Economist magazine (January 24, 2011), in an article entitled ‘Price Rises in China: Inflated Fears,’ wondering if China was beginning to suffer from an Indian-style skewflation.
The distinction between these different kinds of inflation is important because they call for different kinds of policy response from the government. Usually, a high inflation, and in particular core inflation, is taken as a sign of aggregate demand outstripping aggregate supply and is met with monetary and fiscal policy tightening. On the other hand, a relative price increase is often treated as the market’s natural response to exogenous demand and supply shocks and many economists would argue that they are best left with no government intervention. Such relative-price signals are the market’s way of informing consumers and producers what to consume less and what to produce more. To impair these signals does more damage than good.
In terms of policy, skewflation does not fall into either of the above categories neatly. Given that it is sector specific, it is not evident that it calls for monetary or fiscal policy action. On the other hand, given its sustained nature, it is not possible for government to ignore it, since cause stress to consumers.
It is possible to argue that a small amount of skewflation, for instance, up to 2% per annum, centred in the food and non-tradeable sector, is a natural concomitant of high growth in an emerging economy (see Economic Survey 2010-11, Government of India, Ministry of Finance). This is because, as we know from the study of empirical patterns, the purchasing power parity of poor nations tends to catch up with industrialized nations during periods of rapid growth in the former countries. So a small skewflation, usually of up to 2%, may be natural for an economy growing rapidly. However, if such inflation rises to higher levels, government is forced to think of a policy cocktail, consisting of aggregate demand tightening, along with measures to improve the production and supply of goods.