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demystified!!
Terminologies
Inflation is defined as a sustained increase in the general level of prices for
goods and services. It is measured as an annual percentage increase. As
inflation rises, every dollar you own buys a smaller percentage of a good or
service.
There are several variations on inflation:
Wholesale price index (WPI) is an inflation index which takes into account
goods and services at the seller level. This has higher weightage of goods
and services which affect the macro economy while a lesser part of it is
constituted by fuel and food prices.
Consumer price index (CPI) takes into account inflation in goods which
affect a household and hence food and fuel prices have a more prominent
weightage given in this index.
Why do we need to compute inflation for RBI policies?
Most of us have heard of monetary policy but are not quite sure what it
means and what it affects. The thing we need to understand about monetary
policy is that it controls the supply of money in the economy. Simply put, it
controls how much money is flowing into the system. There are some very
interesting tools available with the RBI that help it to achieve this, including
interest rates, cash reserve ratio, statutory liquidity ratio etc.
When RBI controls the supply of money, it has a widespread effect. When the
money flow increases, more people have extra money which they spend on
It shows the actual cash flow on the side of the final consumer
CPI takes into account all the economic realities, including the
taxes and profits of all the middlemen
This measure of inflation takes into account services as well
CPI takes into account the behaviour of wholesalers when it comes
to passing on the price changes to the consumer. This means a
more accurate and predictable action plan over time.
Primarily due to these reasons, it makes sense for RBI to take the CPI inflation
into account while deciding upon the policy changes. RBI has started this
practice since about a couple of years, because we also have a better way of
computing the CPI inflation these days.
Why RBI shifted to CPI over WPI?
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