Inflation: WPI & CPI — Set 12

Correct Answer: C. C. Real estate and financial assets

Real estate prices and financial asset prices (stocks, bonds, gold) are excluded from both CPI and WPI. CPI includes housing rent but not the price of owning a house. WPI covers goods but not financial instruments. Asset price inflation is a growing concern for financial stability even when goods/services inflation is contained.

Correct Answer: B. B. A fixed basket of goods and services representative of average household consumption

India's CPI measures the change in prices of a fixed basket of goods and services that is representative of average household consumption patterns, as determined by the Household Consumer Expenditure Survey. The basket includes food, housing, fuel, clothing, and miscellaneous services. A 'fixed basket' approach means the same items are priced every month.

Correct Answer: B. B. Self-reinforcing cycle where higher wages lead to higher prices and vice versa

The wage-price spiral is a self-reinforcing inflationary cycle: workers demand higher wages to compensate for rising prices → firms raise prices to cover higher wage costs → workers demand higher wages again. This spiral makes inflation persistent and hard to break without deliberate monetary tightening. Breaking the wage-price spiral was a key challenge in 1970s-80s global inflation control.

Correct Answer: B. B. RBI Act 1934 (via Finance Act 2016)

The Monetary Policy Committee (MPC) and its mandate were established through amendments to the RBI Act 1934 inserted by the Finance Act 2016. Specifically, Sections 45ZA to 45ZI were added to the RBI Act, defining the inflation target, MPC composition, voting procedures, and accountability mechanisms. This gave the MPC a statutory basis.

Correct Answer: B. B. Manufactured goods like chemicals, textiles, metals, paper, rubber

WPI for Manufactured Products (WPI-MFG) covers 564 manufactured commodities with a weight of approximately 64.2% in WPI. It includes chemicals and chemical products, basic metals, alloys and metal products, machinery, paper and paper products, textiles, food manufacturing, rubber and plastic products. WPI-MFG is an important indicator of factory-level cost and pricing pressures.

Correct Answer: B. B. If firms and households expect future inflation, they raise prices and wages today, causing actual inflation

The expectations channel: if households expect high future inflation, they demand higher wages now; if firms expect high inflation, they raise prices now to protect margins. These expectational adjustments make future inflation a reality — a self-fulfilling prophecy. This is why central banks emphasise 'anchoring expectations' at low levels through credible communication and action.

Correct Answer: B. B. Core inflation

Core inflation (CPI excluding food and fuel) is more relevant for assessing structural, demand-driven inflationary pressures. Food and fuel prices are volatile due to supply shocks (weather, geopolitics) that monetary policy cannot easily address. Core inflation reflects persistent demand pressures that monetary policy can and should respond to, making it a more policy-relevant indicator.

Correct Answer: B. B. 5.5%

India's average CPI inflation for FY 2021-22 was approximately 5.5%, within the RBI's 2-6% tolerance band. Inflation gradually rose through the year as economic activity resumed post-COVID lockdowns. The acceleration to above 6% in 2022 prompted the RBI's aggressive rate hiking cycle beginning May 2022.

Correct Answer: A. A. WPI was higher due to global commodity price surge while CPI was moderated by supply interventions

During 2020-22, India saw a significant divergence: WPI surged sharply (reaching 15%+ in 2021-22) due to global commodity price spikes (metals, crude oil, chemicals) from post-COVID supply chain disruptions. CPI remained more moderate (5-7%) as food supply interventions, government price controls, and lower service demand partly contained consumer price rises.

Correct Answer: B. B. People base spending on long-term expected income — temporary income changes have smaller consumption effects

The Permanent Income Hypothesis (Milton Friedman, 1957) posits that consumption is based on long-term expected (permanent) income, not current income. A temporary increase in income leads to saving (not spending), limiting inflation. Conversely, temporary inflation is less damaging as people recognise it as transitory. This theory influences how central banks assess whether inflation is transitory or persistent.