Which one of the following indices is now used by the Reserve Bank of India to measure the rate of inflation in India?
Consumer Price Index
RBI's Inflation Measurement Index in India
Understanding how inflation is measured is crucial for economic analysis and policy-making. In India, the Reserve Bank of India (RBI) plays a key role in monetary policy, and measuring inflation accurately is vital for setting interest rates and managing price stability. Over time, the primary index used by the RBI for measuring inflation has changed.
What is Inflation?
Inflation refers to the general increase in the prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. This means that inflation erodes the purchasing power of money.
Different Price Indices
Various indices are used to track price changes. Some commonly discussed indices include:
- Wholesale Price Index (WPI): This index measures the average change in the prices of commodities at the wholesale level. It tracks prices before goods are sold to retailers or consumers. WPI focuses more on producer or wholesale price trends.
- Consumer Price Index (CPI): This index measures the average change over time in the prices paid by urban and rural consumers for a "market basket" of consumer goods and services. It reflects the prices that consumers actually pay. There are different types of CPI, including CPI (Combined) for rural and urban areas, CPI (Industrial Workers), CPI (Agricultural Labourers), etc.
- Stock Market Indices (e.g., NASDAQ, BSE Index): These indices track the performance of a basket of stocks traded on a stock exchange. They reflect investor sentiment and company performance, not the general price level of goods and services consumed by the public.
RBI's Shift to Consumer Price Index (CPI)
Historically, the Reserve Bank of India primarily used the Wholesale Price Index (WPI) to track inflation for monetary policy purposes. However, over time, there was a recognition that the CPI better reflects the impact of price changes on the common consumer and their cost of living. The WPI captures price changes at an earlier stage of the value chain and does not include services, which constitute a significant part of household consumption.
Consequently, the Reserve Bank of India officially adopted the combined Consumer Price Index (CPI Combined - rural and urban) as its key measure for inflation targeting and monitoring, starting in 2014. This aligns India with international practices where CPI is commonly used for monitoring retail inflation and making monetary policy decisions.
Therefore, the index currently used by the Reserve Bank of India to measure the rate of inflation in India is the Consumer Price Index.
| Feature | Wholesale Price Index (WPI) | Consumer Price Index (CPI) |
|---|---|---|
| Level of Transaction | Wholesale level | Retail/Consumer level |
| Coverage | Primarily goods | Both goods and services |
| Focus | Producer/Wholesale prices | Consumer prices/Cost of living |
| RBI's Current Primary Index | No | Yes (CPI Combined) |
Analysing the Options
Based on the current practice:
- NASDAQ Index: This is a US stock index, irrelevant for India's inflation measurement.
- BSE Index: This is an Indian stock index, measures stock market performance, not inflation.
- Consumer Price Index: Measures retail inflation, reflects consumer cost of living. This is the index now used by RBI.
- Wholesale Price Index: Measures wholesale inflation. Previously used by RBI, but no longer the primary index for monetary policy.
The Consumer Price Index is the correct answer as it is the index currently used by the Reserve Bank of India for measuring inflation.
Revision Table: Key Inflation Indices
| Index | What it Measures | Used by RBI for Inflation Target? |
|---|---|---|
| Consumer Price Index (CPI) | Average price change for consumers | Yes (CPI Combined) |
| Wholesale Price Index (WPI) | Average price change at wholesale level | No (primarily for monetary policy) |
Additional Information on Inflation and RBI
The RBI's mandate includes maintaining price stability while keeping in mind the objective of growth. The government has set a target range for inflation for the RBI, typically based on the Consumer Price Index (CPI). The current inflation target is 4% with a band of +/- 2%, meaning the RBI aims to keep CPI inflation between 2% and 6%. The Monetary Policy Committee (MPC) uses CPI data as a key input for deciding the repo rate and other monetary policy tools.
Understanding the difference between WPI and CPI is important because they can sometimes show different trends due to differences in coverage (goods vs. goods and services) and the stage of transaction (wholesale vs. retail). However, over the long term, WPI trends can often influence CPI trends as changes in wholesale prices may eventually be passed on to consumers.
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