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?

The specific purpose of the CPI Signup and view all the answers

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

Essential household expenditures Signup and view all the answers

How can CPIs be made comparable across countries?

By synchronizing item classifications with COICOP Signup and view all the answers

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

It reflects the exact expenditure patterns of households Signup and view all the answers

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

They ensure a comprehensive overview of consumption variations Signup and view all the answers

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

They reduce their investment expenditure. Signup and view all the answers

How does the appreciation of domestic currency affect net exports?

It makes domestically produced goods more expensive. Signup and view all the answers

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

Quantum Channel Signup and view all the answers

What happens to employment when domestic currency appreciates?

Employment in export-oriented industries decreases. Signup and view all the answers

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

Consumers tend to borrow more for major purchases. Signup and view all the answers

What occurs when the domestic currency depreciates?

Exports become more profitable. Signup and view all the answers

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

Decreased spending on non-essential goods. Signup and view all the answers

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

It alters access to bank credit for borrowing needs. Signup and view all the answers

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

Reduction in money supply Signup and view all the answers

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

It raises the cost of capital for firms Signup and view all the answers

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

Consumption, production, and employment decrease Signup and view all the answers

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

It is the minimum cash deposit requirement for banks Signup and view all the answers

Which identifies the role of intermediate targets in monetary policy?

They are variables that can be influenced to a limited degree Signup and view all the answers

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

To stimulate economic activity and drive more lending Signup and view all the answers

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

It often results in lower investment spending Signup and view all the answers

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

It makes RBI hesitant to cut rates due to potential capital outflows. Signup and view all the answers

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

Implementing day-to-day monetary measures Signup and view all the answers

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

They affect output, employment, and inflation Signup and view all the answers

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

A mass exodus of foreign investors from the Indian stock market. Signup and view all the answers

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

Buying securities to lower interest rates and increase money supply. Signup and view all the answers

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

US interest rates significantly influence global capital allocation. Signup and view all the answers

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

Borrowing costs decrease as interest rates fall. Signup and view all the answers

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

Fed rate changes can lead to increased or decreased borrowing costs worldwide. Signup and view all the answers

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

They become more appealing to foreign investors compared to riskier options. Signup and view all the answers

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

Systemic risks 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?

Overnight Reverse Repurchase Agreement Signup and view all the answers

Which statement about WPI and CPI is not accurate?

WPI includes services like housing and education in its basket. 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?

Market Stabilization Scheme Signup and view all the answers

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

Promote maximum employment, stable prices, and moderate long-term interest rates Signup and view all the answers

What does CPI primarily measure in relation to consumers?

Average change in prices at the retail level Signup and view all the answers

Which of the following describes WPI accurately?

It captures changes in prices at the first stage of sales. Signup and view all the answers

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

Their prices can diverge from tradables, affecting the overall CPI. Signup and view all the answers

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

To provide estimates of inflation at the wholesale transaction level. Signup and view all the answers

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

WPI collects prices at ex-factory, ex-mine, and mandi levels, while CPI collects at retail levels. Signup and view all the answers

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

39.1 percent Signup and view all the answers

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

There is often a lag in the spillover effect of wholesale prices to retail levels. Signup and view all the answers

Which organization uses WPI as a deflator for estimating GDP?

Central Statistical Organisation (CSO) Signup and view all the answers

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

Manufacturing inputs and intermediate goods Signup and view all the answers

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

Housing services Signup and view all the answers

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

Differences in weight of food groups in their respective baskets. Signup and view all the answers

Signup and view all the answers

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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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.