Currency (Part-II)

Inflation Rate

• The percentage increase in the general price level of goods and services over a period of time (usually a year).

• Shows how quickly a currency is losing value within its own country.

• If prices rise 5% in a year, a $100 bill now buys what $95 bought before, like a slowly shrinking wallet.

Consumer Price Index (CPI)

• measures how the average cost of a “basket” of common goods and services (like food, fuel, rent, clothes) changes over time.

• Economists use this to calculate inflation

• Imagine a shopping cart filled with typical household items — if the total bill keeps rising, that’s inflation showing up in ___.

Producer Price Index (PPI)

• Tracks the average change in prices received by domestic producers for their goods and services.

• Measures inflation from the producer’s side which often changes before they reach consumers.

• Suppose if the bakery ingredients get pricier before bread prices rises, it’s this that it spots first. 

GDP Deflator

• Measures the overall level of price change for all goods and services produced in a country, not just consumer items.

• The purpose of this is to provide a broad measure of inflation across the whole economy

• CPI watches the price of your groceries meanwhile this thing watches the price of everything, from cars to constructions.

Nominal Exchange Rate

• The rate at which one currency can be exchanged for another in current market terms.

• Shows how much of one currency you get for another today.

• This is like checking the price tag of the currency.

Real Exchange Rate

• The nominal exchange rate adjusted for price differences (inflation) between countries.

• Shows how much more or less foreign goods cost compared to domestic ones.

• If burgers are $5 in the U.S. and ₹250 in India, but $1 = ₹83, then the real exchange rate shows whether it’s cheaper to eat abroad or at home.

Purchasing Power Parity (PPP)

• Compares what the same amount of money can buy in different countries

• Helps to see if currencies are overvalued or undervalued

• If a Big Mac costs $5 in the U.S. but ₹250 in India, PPP says ₹50 per dollar would be the “fair” exchange rate — this is the idea behind The Economist’s “Big Mac Index.”

Real Interest Rate

• The interest rate after subtracting inflation from the nominal rate.

• Tells the true return on savings or cost of borrowing.

• If a bank gives 6% interest but inflation is 4%, your real gain is only 2%.

Index Number

• A statistical tool that tracks changes in a variable over time, usually starting from a base year (set as 100).

• Helps compare values across years easily (e.g., CPI Index 120 means prices rose 20% since the base year)

• Like marking “Day 1” as 100 and watching a plant grow taller each day; the number shows how much it’s grown since the start

Money Supply Indicators (M1, M2, M3)

• These measure the amount of money circulating in an economy

• M1: Cash + checking deposits

• M2: M1 + savings deposits

• M3: M2 + large time deposits

• More money supply can cause inflation and weaken currency value.

• Think of it like water in a tank, too much water (money) overflows and floods prices upward.

Balance of Payments (BoP)

• Records all transactions between a country and the rest of the world, including trade, investments, and money transfers.

• Shows if a country earns more from exports than it spends on imports.

• Think of this like a national bank statement

• If you spend more than you earn abroad, your currency tends to weaken.

Real Wage Index

• The average worker’s income adjusted for inflation.

• Shows whether people’s purchasing power is really increasing or not.

• If your salary rises 5% but prices rise 5% too, your real wage stays flat, of course you are earning more money now but can’t buy more things

Cost-of-Living Index

• A measure of how expensive it is to maintain a certain standard of living in different places or times.

• Compares affordability between cities or countries.

• Living in New York feels pricier than in Boise, this index quantifies that feeling with data.

Effective Exchange Rate (EER)

• An average exchange rate of a country’s currency compared with a group of trading partners, weighted by how much they trade.

• Shows overall currency strength, not just against one currency.

• Like checking your average score across all subjects not just in math

Real Effective Exchange Rate (REER)

• The Effective Exchange Rate adjusted for inflation differences between countries.

• Helps to see if a country’s goods are becoming cheaper or more expensive globally.

• If your prices rise faster than others’, even if your currency’s “score” looks good, your products become too costly abroad