Consumer Price Index Overview
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Questions and Answers

What is the primary purpose of classifying items in the CPI compilation process?

  • To simplify the consumer's understanding of prices
  • To define sub-aggregates that relate expenditure weights and prices (correct)
  • To comply with international trade agreements
  • To organize items based on price fluctuations

Which classification system has most countries adopted for their CPI?

  • HSN (Harmonized System of Nomenclature)
  • CPC (Central Product Classification)
  • COICOP (Classification of Individual Consumption according to Purpose) (correct)
  • ISIC (International Standard Industrial Classification)

What percentage of the CPI is generally unaffected by changes in interest rates?

  • 10-20%
  • 25-30%
  • 90-95% (correct)
  • 50-60%

Which of the following aspects should influence the construction of a CPI?

<p>The specific purpose of the CPI (B)</p> Signup and view all the answers

In the context of the CPI, what do fixed costs include?

<p>Essential household expenditures (B)</p> Signup and view all the answers

How can CPIs be made comparable across countries?

<p>By synchronizing item classifications with COICOP (C)</p> Signup and view all the answers

What is one of the misconceptions regarding the concept of CPI by households?

<p>It reflects the exact expenditure patterns of households (B)</p> Signup and view all the answers

What is the significance of items organized under Groups, Categories, Sub-groups, and Sections in CPI?

<p>They ensure a comprehensive overview of consumption variations (A)</p> Signup and view all the answers

What effect does an increase in interest rates have on firms?

<p>They reduce their investment expenditure. (C)</p> Signup and view all the answers

How does the appreciation of domestic currency affect net exports?

<p>It makes domestically produced goods more expensive. (B)</p> Signup and view all the answers

Which channel influences the access of firms and households to bank credit?

<p>Quantum Channel (A)</p> Signup and view all the answers

What happens to employment when domestic currency appreciates?

<p>Employment in export-oriented industries decreases. (A)</p> Signup and view all the answers

How does a decrease in interest rates generally impact consumer behavior?

<p>Consumers tend to borrow more for major purchases. (B)</p> Signup and view all the answers

What occurs when the domestic currency depreciates?

<p>Exports become more profitable. (A)</p> Signup and view all the answers

Which of the following is a possible consequence of high interest rates on household spending?

<p>Decreased spending on non-essential goods. (A)</p> Signup and view all the answers

What is the primary impact of the credit channel on businesses?

<p>It alters access to bank credit for borrowing needs. (D)</p> Signup and view all the answers

What is the primary effect of the RBI selling government securities during inflation?

<p>Reduction in money supply (D)</p> Signup and view all the answers

How does the balance sheet channel influence production when interest rates increase?

<p>It raises the cost of capital for firms (A), It lowers the capitalized value of fixed assets (D)</p> Signup and view all the answers

What happens to consumption and production when debt securities become more attractive than equity?

<p>Consumption, production, and employment decrease (D)</p> Signup and view all the answers

What does the Cash Reserve Ratio (CRR) represent in monetary policy?

<p>It is the minimum cash deposit requirement for banks (D)</p> Signup and view all the answers

Which identifies the role of intermediate targets in monetary policy?

<p>They are variables that can be influenced to a limited degree (D)</p> Signup and view all the answers

What is the primary goal of Quantitative Easing (QE)?

<p>To stimulate economic activity and drive more lending (D)</p> Signup and view all the answers

What effect does reducing the money supply have on firms that rely on bank loans?

<p>It often results in lower investment spending (B)</p> Signup and view all the answers

How does an increase in the Fed Fund Rates impact the RBI's decisions?

<p>It makes RBI hesitant to cut rates due to potential capital outflows. (C)</p> Signup and view all the answers

What is a key operating procedure of the central bank related to monetary policy?

<p>Implementing day-to-day monetary measures (D)</p> Signup and view all the answers

What does the standard asset price channel indicate about changes in credit policy?

<p>They affect output, employment, and inflation (B)</p> Signup and view all the answers

What is a consequence of a rising Fed Fund Rate for investors in India?

<p>A mass exodus of foreign investors from the Indian stock market. (A)</p> Signup and view all the answers

Which of the following correctly describes the action involved in Quantitative Easing?

<p>Buying securities to lower interest rates and increase money supply. (B)</p> Signup and view all the answers

What effect does the Fed's monetary policy have on global capital flows?

<p>US interest rates significantly influence global capital allocation. (D)</p> Signup and view all the answers

What happens to the borrowing costs when a central bank enacts Quantitative Easing?

<p>Borrowing costs decrease as interest rates fall. (A)</p> Signup and view all the answers

Which of the following describes the relationship between the Fed’s actions and the global borrowing market?

<p>Fed rate changes can lead to increased or decreased borrowing costs worldwide. (D)</p> Signup and view all the answers

What is the impact of higher US interest rates on safe investments in the US?

<p>They become more appealing to foreign investors compared to riskier options. (B)</p> Signup and view all the answers

What does the US FED primarily seek to minimize and contain through active monitoring?

<p>Systemic risks (A)</p> Signup and view all the answers

What type of agreement does the Federal Reserve engage in when it sells a security and agrees to buy it back the next day?

<p>Overnight Reverse Repurchase Agreement (A)</p> Signup and view all the answers

Which statement about WPI and CPI is not accurate?

<p>WPI includes services like housing and education in its basket. (D)</p> Signup and view all the answers

Under which scheme does the Government of India borrow from the RBI to absorb excess liquidity from large capital inflows?

<p>Market Stabilization Scheme (B)</p> Signup and view all the answers

What is the primary purpose of the Federal Reserve System in conducting monetary policy?

<p>Promote maximum employment, stable prices, and moderate long-term interest rates (B)</p> Signup and view all the answers

What does CPI primarily measure in relation to consumers?

<p>Average change in prices at the retail level (D)</p> Signup and view all the answers

Which of the following describes WPI accurately?

<p>It captures changes in prices at the first stage of sales. (A)</p> Signup and view all the answers

What is a key characteristic of non-tradables in the context of CPI?

<p>Their prices can diverge from tradables, affecting the overall CPI. (D)</p> Signup and view all the answers

What is one of the main uses of the Wholesale Price Index (WPI)?

<p>To provide estimates of inflation at the wholesale transaction level. (C)</p> Signup and view all the answers

How does WPI differ from CPI in terms of the price collection level?

<p>WPI collects prices at ex-factory, ex-mine, and mandi levels, while CPI collects at retail levels. (B)</p> Signup and view all the answers

What is the weight of the food group in the Consumer Price Index (CPI) basket?

<p>39.1 percent (C)</p> Signup and view all the answers

Why might price movements in the WPI basket not immediately affect the CPI?

<p>There is often a lag in the spillover effect of wholesale prices to retail levels. (D)</p> Signup and view all the answers

Which organization uses WPI as a deflator for estimating GDP?

<p>Central Statistical Organisation (CSO) (C)</p> Signup and view all the answers

What type of goods does a significant proportion of the WPI item basket represent?

<p>Manufacturing inputs and intermediate goods (D)</p> Signup and view all the answers

Which of the following is NOT included in the WPI basket?

<p>Housing services (A)</p> Signup and view all the answers

What is one reason for the divergence between WPI and CPI?

<p>Differences in weight of food groups in their respective baskets. (B)</p> Signup and view all the answers

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Flashcards

Interest Rate Channel

Monetary policy's impact on borrowing costs, affecting investment and consumer spending.

Exchange Rate Channel

The influence of currency exchange rates on the prices of imported and exported goods, affecting trade.

Quantum Channel

Monetary policy's effect on the money supply and credit availability, impacting business and household borrowing.

Bank Lending (Credit) Channel

A mechanism within the Quantum Channel where banks adjust credit access for businesses and households.

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Balance Sheet Channel

A mechanism within the Quantum Channel where changes in the balance sheets of firms and households influence their borrowing.

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Currency Devaluation

A strategy to intentionally weaken a currency to boost exports and domestic production.

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Decline in Aggregate Demand

The effect of a decline in aggregate demand leading to a reduction in overall output and goods production.

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Increase in Aggregate Demand

The opposite effect of a decline in aggregate demand, where increased spending leads to increased production.

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Credit Restriction

The reduction of money in the economy through the sale of government securities, aiming to curb inflation by limiting credit availability.

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Balance Sheet Channel Effect

The impact of higher interest rates on firm balance sheets, leading to higher debt costs and reduced fixed asset value, ultimately affecting investment and production.

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Asset Price Channel

The influence of changes in credit policy on asset prices, particularly affecting share prices and investor wealth.

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Operating Framework of Monetary Policy

The framework defining how various aspects of monetary policy are implemented and managed by a central bank.

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Operating Target

The variable or measure that monetary policy aims to directly influence.

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Intermediate Target

A variable that the central bank aims to influence indirectly through its policies, hoping to achieve broader economic stability.

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Credit Policy Instruments

The tools and methods utilized by a central bank to manage the money market and credit conditions, achieving its monetary policy objectives.

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Cash Reserve Ratio (CRR)

The percentage of a commercial bank's deposits that they must hold as reserves with the Reserve Bank of India.

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Reserve Requirement

The Federal Reserve's requirement for banks to hold a portion of their deposits in cash, ensuring financial stability.

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Fed Funds Rate

The interest rate at which banks lend reserves to each other overnight, serving as a benchmark for other interest rates.

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US Interest Rate Impact on Global Markets

The influence of changes in US interest rates on global capital flows.

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Quantitative Easing (QE)

A monetary policy strategy used by central banks to increase the money supply and stimulate the economy by purchasing government and corporate bonds.

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QE's Impact on Interest Rates

The process by which QE lowers longer-term interest rates, reducing borrowing costs for businesses and consumers.

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QE's Impact on Money Supply

QE's effect on the availability of money in circulation, leading to lower borrowing costs and stimulating economic growth.

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Interest Rate Policy

The deliberate intervention of central banks to control interest rates, often targeting short-term market rates.

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Comparing Interest Rate Policy and QE

The difference between interest rate policy's focus on short-term rates and QE's focus on long-term rates.

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What does the WPI measure?

The Wholesale Price Index (WPI) tracks price movements at the bulk sale level, representing the initial stage of transactions.

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How does the WPI help control inflation?

WPI is used to calculate inflation at the wholesale level. This information helps the government intervene early to control prices of essential goods before they impact consumers.

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What is a key use of the WPI in economic calculations?

The WPI is used as a deflator in various economic calculations, like estimating the GDP by the Central Statistical Organisation (CSO).

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How is the WPI used in business contracts?

The WPI serves as a benchmark for indexation in business contracts, ensuring adjustments for price changes over time.

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What does the CPI measure?

The Consumer Price Index (CPI) reflects the average price changes at the retail level, which is what consumers actually pay.

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What is the key difference between the WPI and the CPI?

The WPI focuses on bulk sales at the beginning of the supply chain while the CPI tracks prices at the end, when consumers buy goods.

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What are some key differences between the WPI and CPI baskets?

The CPI includes services like housing, education, and healthcare, which are not part of the WPI. The WPI basket heavily features manufacturing inputs and intermediate goods not directly consumed by households.

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Why might changes in the WPI not immediately reflect in the CPI?

Changes in wholesale prices (WPI) may not immediately impact retail prices (CPI) because consumers often experience a lag due to factors like inventory and distribution.

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COICOP (Classification of Individual Consumption according to Purpose)

A hierarchical structure that organizes products and services consumed by households into categories based on their purpose. It helps ensure consistent and comparable price data across different countries.

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Classification of Items in CPI

The initial step in creating a CPI involves categorizing products and services based on their purpose, ensuring that price data aligns with the spending patterns of the population.

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Consumer Price Index (CPI)

A measure of the average change in prices paid by urban consumers for a basket of goods and services. It is used to track inflation.

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CPI and Interest Rates

The CPI does not fully capture the impact of interest rate changes on household spending. A large portion of household expenses, such as food and housing, are not directly influenced by interest rate fluctuations.

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CPI and Household Spending

The CPI focuses on the average price changes for a basket of goods, not the individual experience of each household. This means that the CPI might not accurately reflect the price changes experienced by all consumers.

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CPI Relevance to Country Context

It's important to adapt the CPI classification system to the specific context of a country to ensure it reflects local spending patterns and accurately reflects the prices consumers face.

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Harmonizing CPI Classification with COICOP

To ensure consistency and comparability across different countries, it is desirable to align the classification of items within the CPI with the internationally recognised standard, COICOP.

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Clear Definition and Naming of CPI Variants

A well-defined and accurately named CPI is essential to avoid ambiguity and confusion in data interpretation, ensuring clear communication about inflation and its impact on consumers.

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WPI vs. CPI

The Wholesale Price Index (WPI) measures price changes for goods sold in bulk at the first stage of transaction, while the Consumer Price Index (CPI) reflects the average change in prices paid by consumers at the retail level.

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Price Gap: WPI & CPI

The difference in price movements between the WPI and CPI can be attributed to the inclusion of non-tradable items in the CPI basket.

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Relative Price Trends: WPI & CPI

The relative price trends of tradable goods compared to non-tradable goods play a key role in explaining the short-term divergence between the WPI and CPI indices.

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The Fed's Role: Systemic Risks

The US Federal Reserve (Fed) actively monitors and engages in financial markets to minimize and contain systemic risks, which are risks that could destabilize the entire financial system.

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Overnight Reverse Repurchase Agreement (RRP)

An Overnight Reverse Repurchase Agreement (RRP) involves the Fed selling a security to a counterparty with an agreement to buy it back the next day.

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Market Stabilization Scheme

The Market Stabilization Scheme is a program where the Indian government borrows from the Reserve Bank of India (RBI) and issues treasury bills or bonds to absorb excess liquidity caused by large capital inflows.

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Liquidity Adjustment Facility (LAF)

The Liquidity Adjustment Facility (LAF) is a mechanism used by the RBI to adjust liquidity in the money market by lending or borrowing from commercial banks through overnight repurchase agreements and reverse repo agreements.

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Margin Standing Facility (MSF)

Margin Standing Facility (MSF) is a window provided by the RBI to commercial banks that helps them to borrow additional funds overnight to meet their short-term liquidity needs.

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Study Notes

Impact of Various Policies of Financial Markets

  • Learning outcomes: Students will understand Credit Policy of RBI, Fed Policy, and Inflation Indices (CPI, WPI, etc).

Chapter Overview

  • Credit Policy of RBI: Meaning, objectives, analytics, operating procedures, and instruments.
  • Fed Policy: Meaning, objectives, analytics, operating procedures, instruments, impact on global financial markets, and quantitative easing.
  • Cost Inflation Index: Concept, computation, and classification.
  • Consumer Price Index: Concepts and computation, issues related to CPI.
  • Wholesale Price Index: Introduction and differences between CPI and WPI

Credit Policy of the Reserve Bank of India (RBI)

  • Meaning: A plan of action by RBI to control and regulate money demand and supply in India.
  • Objectives:
    • Maintain price stability (controlling inflation): RBI uses interest rates, increasing to cool down and decreasing to increase inflation.
    • Achieve economic growth: A balance between price stability and economic growth is maintained.
    • Exchange rate stability: Maintaining a stable exchange rate (e.g., reducing rupee depreciation).

Analytics of Credit Policy

  • Mechanisms for influencing price level and national income:
    • Interest Rate Channel: Higher interest rates decrease investment and spending. Lower interest rates increase investment and spending
    • Exchange Rate Channel: Appreciation of domestic currency makes domestically produced goods more expensive
    • Quantum Channel: Impacts firms' access to credit
    • Asset Price Channel: Interest rate changes affect financial asset prices, impacting consumption, production, and employment.

Operating Procedure and Instruments

  • Cash Reserve Ratio (CRR): The amount of money commercial banks must keep with RBI.
  • Statutory Liquidity Ratio (SLR): The amount of money commercial banks must keep with themselves.
  • Liquidity Adjustment Facility (LAF): Enables banks to borrow from RBI.
  • Repo/Reverse Repo Transactions: Commercial banks borrow/lend to/from RBI via securities.
  • Margin Standing Facility (MSF): An additional borrowing facility for commercial banks at a penalty rate.
  • Market Stabilization Scheme: Used to absorb liquidity by government.
  • Open Market Operations: Monetary policy tool to control liquidity by buying/selling securities.

Fed Policy

  • About the Federal Reserve System: The central bank of the US.
  • Fed Policy Tools:
    • Open Market Operations: Buying/selling securities
    • The Discount Rate: Interest rate charged to commercial banks
    • Reserve Requirements: Reserve amount that depository institutions must hold against liabilities.
    • Interest on Required Reserve Balances and Excess Balances Eliminates an implicit tax on required reserves.

Cost Inflation Index (CII)

  • A measure of inflation used for computing long-term capital gains.
  • Used for calculation of capital assets and the impact of inflation in their value.

Consumer Price Index (CPI)

  • Measures changes in average retail prices of goods and services consumed by households.
  • Used in inflation calculation and for price adjustments.

Wholesale Price Index (WPI)

  • Measures the average change in prices of commodities for bulk sale at the early stage of transaction.
  • Consists of Primary Articles, Fuel and Power, and Manufactured Products.

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Impact Of Various Policies Of Financial Markets PDF

Description

This quiz explores key concepts related to the Consumer Price Index (CPI), including its classification, construction influences, and the impact of interest rates. Test your knowledge on how CPI is affected by economic changes and misconceptions surrounding it. Ideal for economics students and professionals looking to deepen their understanding of CPI.

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