Price Stability

Define price stability

General price level rising slowly and predictably; slow & stable inflation rate

Define inflation

Sustained increased in GPL in the economy

Define deflation

Periods of falling overall prices in the economy

What is used to measure inflation?

Consumer Price Index (CPI)

• Measured by % changes in the CPI → represents inflation rate

Define CPI

Weighted average of prices of a basket of g&s that is purchased by the average household within a given time period.

How do we calculate inflation rates?

Inflation rate = [(CPI2 - CPI1)/CPI 1] × 100

Limitations of Consumer Price Index (CPI)

• Does not reflect inflation on diff grps

• Limited in long term comparison

• Does not reflect quality changes

Why Is CPI not reflect diff inflation for diff groups

Different households have different consumption patterns (e.g. expatriates and those extremely wealthy not considered normal household)

Separate indices for different subgroups can be used to better estimate inflation for different households.

Why is CPI limited in long term comparisons?

The items in the basket must be revised, as over a long period of time, the expenditure patterns between the base year and the current year may vary significantly, making CPI inaccurate.

Why is CPI limited in quality changes?

CPI reflects price changes and not quality changes over time, overstating inflation.

What other indicator is closely tied to CPI?

PPI (producer price index) that measures the average % change in the prices of goods bought by producers.

Movements in PPI would lead to movements in CPI in later months.