Inflation and Price Indices: WPI, CPI and Exam Notes

The correct answer is B, the Consumer Price Index (Combined). When the flexible inflation targeting framework was adopted after the amendment of the Reserve Bank of India Act in 2016, the combined rural and urban consumer price index released by the National Statistical Office was made the nominal anchor, as the Urjit Patel Committee had recommended. It was chosen because it measures the prices households actually pay and includes services.

Option A, the wholesale price index, was the headline measure before this change, but it covers only goods traded in bulk and no services at all. Option C, the Index of Industrial Production, measures the volume of industrial output and is not a price index. Option D, the GDP deflator, is the broadest price measure but is published only with the national accounts, far too late for a monthly policy decision.

The correct answer is C, the Office of the Economic Adviser. The wholesale price index is compiled and released every month by the Office of the Economic Adviser in the Department for Promotion of Industry and Internal Trade, under the Ministry of Commerce and Industry. Its three groups are primary articles, fuel and power, and manufactured products, and the series released in 2017 has 2011-12 as its base year.

Option A, the Reserve Bank of India, uses price indices for monetary policy but does not compile them. Option B, the Labour Bureau under the Ministry of Labour and Employment, compiles the consumer price indices for industrial workers and for agricultural and rural labourers. Option D, the National Statistical Office, compiles the combined consumer price index and the national accounts.

The correct answer is B, demand-pull inflation. It is described in the classic phrase as too much money chasing too few goods. A rapid growth of money supply, a large increase in government spending, easy credit or a sudden rise in exports can push total demand beyond what the economy can produce at current prices, and prices then rise to clear the market.

Option A, cost-push inflation, works from the supply side, when costlier crude oil, higher wages or dearer imported inputs raise the cost of production and producers pass it on. Option C, structural inflation, comes from bottlenecks such as poor storage, weak transport or shortages of skilled labour. Option D, imported inflation, is a form of cost-push in which a fall in the value of the currency or a rise in world prices makes imports dearer.

The correct answer is C, stagflation. The word joins stagnation and inflation, and it describes the awkward situation in which prices are rising fast while output is flat and unemployment is high. It is difficult to treat, because raising interest rates to control prices depresses output further, while stimulating demand to create jobs pushes prices higher still. The oil shocks of the 1970s produced the best known episode of stagflation in the world economy.

Option A, reflation, is a deliberate policy of raising demand and prices after deflation. Option B, disinflation, is a fall in the rate of inflation while prices still rise. Option D, deflation, is an actual fall in the general price level and usually goes with weak demand rather than with high inflation.

The correct answer is A, borrowers. A loan is repaid in a fixed number of rupees, and inflation reduces what those rupees can buy. The borrower therefore returns money of smaller real value than the money received, so the real burden of the debt falls. Producers and traders who hold stocks of goods gain in the same way, since the value of what they hold rises with the price level.

Option B, lenders, lose for the same reason, because the interest they receive may not even cover the loss of purchasing power. Option C, pensioners, live on fixed payments and lose unless the pension is indexed to prices. Option D, holders of fixed deposits, earn a fixed nominal rate; when inflation is higher than that rate the real return is negative and their savings shrink in value.

The correct answer is B, disinflation. If the inflation rate falls from seven per cent to five per cent, prices are still higher than last year but they are rising more slowly. That slowing is disinflation, and it is normally what a central bank is trying to achieve when it raises interest rates to fight high inflation.

Option A, deflation, means that prices themselves are falling and the inflation rate has become negative, which signals weak demand and is far more damaging. Option C, stagflation, is high inflation with low growth and high unemployment. Option D, skewflation, is a sharp rise in the prices of a few commodities, typically food, while the general price level stays broadly stable. This question is a favourite because candidates read deflation and disinflation as the same idea.

The correct answer is C, six. The Monetary Policy Committee set up under the amended Reserve Bank of India Act has six members. Three are from the Reserve Bank, namely the Governor, the Deputy Governor in charge of monetary policy and an officer of the Bank nominated by its Central Board, and three are external members appointed by the Central Government. The Governor chairs the committee and has a casting vote if the votes are equally divided, the quorum is four members and the committee must meet at least four times a year.

Options A, B and D give the wrong strength. The committee decides the policy repo rate by majority, and its resolution is published with the votes of each member, which is a further detail examiners like to ask.

The correct answer is D, services. The wholesale price index is built entirely from the prices of goods traded in bulk, and it has exactly three major groups: primary articles, fuel and power, and manufactured products, of which manufactured products carry the largest weight. A haircut, a school fee, a bus fare or a doctor's charge never enters the index, even though services make up more than half of the country's output. A separate producer price index that would cover services has long been under preparation.

Options A, B and C name the three groups that the index does cover, so none of them can be the answer. The absence of services is one reason the consumer price index, which includes them, was preferred as the anchor for monetary policy.

The correct answer is C, minus 2 per cent. The real rate of interest is the nominal rate less the rate of inflation, an approximation known as the Fisher equation. Here six per cent minus eight per cent gives minus two per cent, so the deposit grows in rupees but buys less at the end of the year than the original sum would have bought at the start. Savers lose in real terms whenever inflation is higher than the interest they earn, and that is a common condition in an economy with high inflation and administered deposit rates.

Option A adds the two rates instead of subtracting them. Option B subtracts in the wrong direction and gives a positive real return. Option D simply repeats the inflation rate and ignores the interest earned.

The correct answer is B, nominal GDP divided by real GDP, multiplied by 100. Nominal GDP is measured at current prices and real GDP at the prices of a base year, so the ratio between them isolates the effect of the change in prices. The deflator is the broadest price measure available, because it covers every good and service produced within the country, and unlike the wholesale and consumer indices its basket changes as the composition of output changes.

Option A inverts the formula and would fall when prices rise. Option C gives an absolute difference in rupees, not an index number. Option D describes per capita GDP, which measures income per head and has nothing to do with the measurement of prices. A deflator of 120 means that prices in the current year are twenty per cent above the base year level.