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India’s Inflation Process Before and After Flexible Inflation Targeting

Summary:
Patrick Blagrave and Weicheng Lian in their new IMF research: We study the inflation process in India, focusing on the periods before and after the adoption of flexible inflation-forecast targeting (FIT) in India. Our analysis uses several approaches including standard Phillips curve estimation for headline and core inflation, an examination of the sensitivity of medium-term inflation expectations to inflation surprises, and the properties of convergence between headline and core inflation. Results indicate an important role for domestic factors in driving the inflation process, and there is evidence that expectations have become more anchored since 2015. This result could be attributable to FIT adoption, or to persistently low food prices which dominate the post-FIT-adoption period.

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Patrick Blagrave and Weicheng Lian in their new IMF research:

We study the inflation process in India, focusing on the periods before and after the adoption of flexible inflation-forecast targeting (FIT) in India. Our analysis uses several approaches including standard Phillips curve estimation for headline and core inflation, an examination of the sensitivity of medium-term inflation expectations to inflation surprises, and the properties of convergence between headline and core inflation. Results indicate an important role for domestic factors in driving the inflation process, and there is evidence that expectations have become more anchored since 2015. This result could be attributable to FIT adoption, or to persistently low food prices which dominate the post-FIT-adoption period. The policy implications of these structural changes in the inflation process are investigated using a semi-structural model calibrated to the Indian economy.

One caveat for our analysis is that we do not rule out a possibility that subdued food price inflation caused by persistent supply shocks stood behind the patterns we document. Nevertheless, our findings support the notion that FIT is performing well in India.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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