Question

Inflation rose by 5% over the second quarter, by 4% during the first quarter, and higher than the 3% recorded during the same time last year. However, the higher price index did not seem to alarm the National Stock Index, as stock prices remained steady. Which of the following, if true, could explain the reaction of the National Stock Index?

• A. RBI announced that it will take necessary corrective measures.
• B. Stock prices were steady because of a fear that inflation would continue.
• C. Economists warned that inflation would continue.
• D. Much of the quarterly increase in the price level was due to a summer drought effect on food prices.

Hint:

Look for a reason that makes the inflation spike look temporary, since that is what would keep investors calm.

Answer 1

The Correct Option is D

The puzzle here is why the stock market stayed calm despite rising inflation figures. A good explanation should give investors a reason not to worry, such as a sign that the inflation spike is temporary.

1. RBI will take corrective measures: This is a promise of future action, but it does not by itself guarantee markets would already be calm now, since corrective steps can take time to work or could even unsettle markets in the short run.
2. Stocks steady due to fear inflation continues: This is self-contradictory as an explanation, since fear of continuing inflation would usually unsettle, not steady, stock prices.
3. Economists warned inflation would continue: A warning of continuing inflation should worry investors, which is the opposite of a steady, calm market, so this does not explain the calm reaction.
4. Drought effect on food prices: If much of the price rise came from a one-off summer drought hitting food prices, investors can reasonably expect the effect to fade once the drought passes, which is a clear, specific reason to stay calm about the inflation numbers.

Only the drought explanation gives a solid, specific reason for investor confidence.

So the correct answer is option D.