CPI, PPI, GDP Deflator, and the XR
For this box you will analyze different measures of inflation. Inflation is the increase of prices over time; however, there are several ways of doing so, and some measures may be more relevant than others for a particular question.
The cost of a representative basket of household consumption goods is given by the CPI (Consumer Price Index); the equivalent for firms is the PPI (Producer Price Index); and the broadest measure of prices is the GDP deflator which is defined as the ratio of Nominal GDP to Real GDP. Firms involved with foreign markets either in goods, services, or capital, pay attention to the relative value of the U.S. Dollar, that is, the exchange rate.
Since the dollar is quoted against other currencies on a one-to-one basis, one way to have an aggregate measure of the value of the dollar is to weigh all currencies on a trade basis, this gives rise to the Trade Weighted U.S. Dollar Index. This measure is also relevant because the value of the dollar can pass-through to domestic prices; where a weak (strong) dollar can push inflation up (down) as the cost of imports rises (falls).
Get the following series from the St. Louis Federal Reserve Bank FRED database from 1960 onwards:
– CPI: Consumer Price Index for all Urban Consumers: all Items (monthly)
– PPI: Producer Price Index for all Commodities (monthly)
– Gross Domestic Product: Implicit Price Deflator (quarterly)
– Trade Weighted U.S. Dollar Index: Broad (monthly)
These series are indices (in levels) so calculate their annualized growth rate (see accompanying document) and plot each of the last three series separately against the CPI [25 points each].
The purpose of this box is to document and describe the co-movement of these price indicators. Your writing should reflect familiarity to the concepts and definitions and should unify them into a common framework [25 points].
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