what is the role of the CPI as an economic tool of measurement?

Question

what is the role of the CPI as an economic tool of measurement?

Answer 1

Nice question. It actually surrounds the thesis i wrote for my Honours degree. As you may be aware, the CPI (Consumer Price Index) is a basket of normal goods, such as bread, milk so forth. The price of these normal goods are compared to see if any inflation, deflation or stagflation has occured.

The CPI is looked at, as well as the PPI (Producer Price Index) which is the same as the CPI except it uses normal industry prices of products to create products, by reserve banks to see if they need to increase/decrease the interest rate as to keep a cap on inflation/deflation/stagflation.

Perhaps the most important use of the CPI is that of exchange rates. Using simple econometric terms, both the CPI and the PPI are used in constructing nominal exchange rates between countries. From here we can find the real exchange rates of countries and test PPP (Purchasing Power Parity) as well as LOOP (Law of One Price) that goes hand in hand with PPP. So the simple calculation of the CPI is used in complicated econometric models to create real exchange rates which impact bonds, interest rates, stocks, and loans.

I hope this helps