Professional Documents
Culture Documents
In Indian context, an empirical exercise by RBI based on annual data for the 57 year period,
1952-53 to 2009-10, shows that there is a co-integrating long-term equilibrium relationship
among inflation, non-agricultural GDP and money supply
First, non-agricultural GDP has a highly significant and negative relationship with inflation,
which implies that an increase in non-agricultural GDP representing improved supply
condition will decrease inflation.
Second, money supply has a highly significant and positive relationship with inflation. One
per cent increase in money supply in absence of any increase in non-agricultural GDP could
lead to 0.9 per cent increase in inflation.
Third, alongside increase in money supply by one percent, if non-agricultural GDP also
increases by one per cent it will have a dampening effect on inflation. But still inflation could
go up by 0.15 per cent in the long-run.
Fourth, deviation from the long-run equilibrium is statistically significant and the adjustment
towards the long-run equilibrium is faster through changes in the non-agricultural GDP.
Fifth, there is a two way causal relationship between money supply and prices.
Inertial Inflation
Inertial inflation is when inflation rate persists at
the same rate. Economists compare inertial
inflation with a lazy dog. If the dog is not
shocked by the push of a foot or the pull of cat.
1990s inflation rate in USA rose steadily around
3 per cent and most people came to expect that
3 percent is the inflation rate for USA. Similarly,
in India single digit inflation is inertial inflation.
During 2004-08 the inflation rate was 5- 5.5 %
the inflation expectation became 5%
Inflation expectations
Prolonged high inflation even if originating from supply
side would give rise to increased inflation expectations
and cause general prices to rise.
Poorly anchored inflation expectations make long-term
financial planning more complex with potential adverse
effects on investment and growth.
Moreover, high inflation is the most regressive form of
taxation, particularly on the poor.
It is, therefore, important to contain inflation and keep
inflation expectations anchored so that consumers do
not mark up their long-run inflation expectations by
reacting to a short period of higher-than-expected
inflation.
Measurement of inflation:
India
Measurement of inflation:
India
Decadal Average
Inflation Decades
WPI
1971-72
to
1980-81 10.3
CPI-IW
8.3
GDP Deflator
PFCE Deflator
8.8
1981-82
to
1990-91 7.1 9.0
8.7
1991-92
to
2000-01 7.8 8.7
8.1
2001-02
to
2008-09 5.2 5.3
4.6
Long-term Trend
7.7 8.0
(1971-72 to 2008-09)
Source: RBI
8.4
8.3
8.5
4.4
7.7
7.6
Since 2008, there has been a divergence between CPI and WPI.
Why?
This could be attributed to the following factors.
First, the price of minerals and metals went up sharply during MayJune 2008 and then fell precipitously reflecting global trends. Since
metals and alloys do not form a part of the CPI group, this
accentuated the divergence between CPI and WPI.
Second, there was a similar trend as metals in crude prices which had
a larger influence on WPI than CPI.
Third, price of services - such as, medical care, education, recreation
and amusement, transport and communication and personal care and
effects - in CPI-IW showed a significant inflation of over 8 per cent.
It may, however, be indicated that CPIs recorded very similar trends
as the food component of WPI despite the divergence of the overall
indices during the recent period.
Core Inflation
The inflation rate covering all the components of WPI is Headline
inflation. Normally the analysis of inflation takes into account Head line
Inflation
Another way to analyse inflation data is by looking at core inflation,
which is generally a chosen measure of inflation that excludes the more
volatile categories like food and energy prices. The main argument here
is that the central bank should effectively be responding to the
movements in permanent component of the price level rather than
temporary deviations.
In Indian context, the derivation of core inflation by exclusion of food and
energy from CPI/WPI discards a substantial portion of the commodity
basket. So the price movement of the remaining commodities may not be
representative of the underlying inflationary trend. Although these prices
have substantial effects on the overall index, they often are quickly
reversed. But the reversal of volatile prices sometimes is not short-lived.
Therefore, determining when to use a core inflation measure versus an
overall inflation measure remains a complex issue.
Inflation Dynamics
Threshold inflation
Threshold inflation is the inflation rate the
country will sustain not having an adverse
impact on growth.
In Indian context the threshold inflation has
been discussed and the agreement is that 56 percent inflation rate is acceptable.
The RBI has a mandated objective in its
monetary policy for price stability. The long
term objective is 3-4 per cent inflation rate.