An Evaluation of Core Inflation Dynamics and Its Impact on Macroeconomic Performance in India (Record no. 75688)

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Language code of text/sound track or separate title eng
Personal name Mallick, Arundhati
Roll Number/Miscellaneous information 512HS1009
Title An Evaluation of Core Inflation Dynamics and Its Impact on Macroeconomic Performance in India
Year of publication 2017
Number of Pages 146 p.
Degree Type Thesis Ph.D
Name of granting institution National Institute of Technology, Rourkela
520 ## - SUMMARY, ETC.
Summary/Abstract, etc The term ‘core inflation’ got popularised when central banks of some countries’ like, Australia, Finland, Canada, New Zealand, Spain, Sweden, and the United Kingdom shifted their focus to inflation targeting. These seven countries broke the tradition of exchange rate and multiple objectives of monetary policy frameworks and adopted one single objective of inflation targeting. Failure of other monetary policy regimes leads to adoption of this new monetary framework of inflation targeting. The monetary targeting framework failed in mid-1980 because of unstable demand for money function and the fixed exchange rate regime also collapsed in the early 1990’s. Canada and New Zealand are the first to adopt inflation targeting framework to improve the inflationary scenario of the economy later five other countries adopt inflation targeting, whereas their level of inflation was already comparatively low. These seven countries had a very poor record of fighting with high level of inflation for past 30 years before adopting inflation targeting framework. But after adopting inflation targeting, these countries have the record of both low inflation and monetary policy credibility. The main motives behind adopting inflation targeting or following core inflation are a low and stable inflation is a needed base for economic growth, and better macroeconomic performance. However, manipulating monetary policy in short period to achieve the goal of higher output or employment may create a conflict with price stability. Inflation targeting or maintaining a low and stable inflation can be possible if central banks follow a specific measure like core inflation.<br/>Inflation in India is a serious and chronic problem because production depends on monsoon in agriculture sector, poor infrastructure facilities for transport of food items to the market and lack of proper storing facilities and energy import. The government has also historically heavily borrowed to finance its spending which leads to a high level of inflation due to high fiscal deficit. These are the main reasons of high inflation in India. The annual CPI from 1960 to 2016 has averaged at 7.6% in 16 of those years; CPI has been in double digits and above 6% in 35 of 56 years. Even in the post 1991 reform era, CPI has averaged above 6% for 17 of 25 years. India has been following the multiple objectives approach to conduct monetary policy. Recently, it has shifted to inflation targeting monetary policy framework. However, India is ready to adopt inflation targeting approach. Under inflation targeting approach, India has to focus on a single objective to maintain low inflation. To do this, it will focus on core inflation by ignoring supply side problem of inflation but for India supply side problem is more serious problem due to its poor infrastructure and tradition practice of farming. From the above reasons India adopted a flexible inflation targeting approach. That is, it adopted inflation targeting approach for short period of time from 5th August 2016 to March 31st 2021 and the level of inflation to be maintained is also flexible. This is good for making central bank of India for more accountable, transparent and improves the credibility of monetary policy.<br/>To estimate core inflation, it is not justifiable to exclude food and fuel items from the price index. Every time all the food items are not volatile. Blindly excluding these items to get core inflation is not justified. So, our study tries to find out an alternative measure of core inflation suitable for Indian economy. Other than finding an alternative measure of core inflation, the study also focuses what the other factors are contributing to India’s inflation role of asset price and external shocks in India’s inflation. A shock from world economy and fluctuations in asset price also affectsthe headline inflation. Hence, we need to find out volatility of these factors which has long term or short term impact on headline inflation. Short run impact form these fluctuations can be excluded while measuring core inflation. It is ensuring that the monetary policy of India needs to focus on core inflation. Other than the above problems, one of the major reasons to focus on core inflation is that, RBI as an authority to control monetary policy, other than targeting inflation, it also focuses on the growth rate. It has to manage the trade-off between growth rate and inflation rate. Ultimate and important motive of an economy is to achieve economic growth. Final aim of this study is to find out how above discussed factors are contributing to economic growth and macroeconomic performance of India.<br/>To empirically analyse the study, we have used some simple statistical tools and some econometric techniques. Our first objective is to analyse the existing measures of core inflation for India and to check the dynamic relationship between headline and core inflation. To analyse this,in statistical approach, we have used the simple statistical tools like mean, standard deviation, covariance etc. and for model based approach we have used the econometrics technique like Structural Vector Auto Regression (SVAR). After getting all the series of core inflation, we try to find out the existing dynamic relation headline inflation and core inflation. We have used Vector Error Correction (VECM) Model to identify this dynamic relation. Our second objective is to find out the domestic and imported core inflation for India. Volatility in food prices are not the only reason, which creates short run or temporary fluctuations in the price index. Sometimes price of various commodities directly or indirectly get affected by changes in the world economy. To analyse this, first we separated goods of price index in to two categories i.e. tradable and non-tradable goods. Tradable goods are mostly associated with world economy and fluctuations in the world economy leads to affect the domestic economy through these goods and non-tradable goods purely represent the fluctuations in the domestic economy. In the first objective the study, we use WPI to represent the inflation but WPI does not include non-tradable goods or service sectors in the index, for this reason we use CPI instead of WPI to represent the inflation of the Indian economy. First, we categorise CPI index into two different sectors i.e. tradable and non-tradable goods, then we try to find out how fluctuations in the world economy transmitted to domestic economy through tradable goods by using Vector Auto-regression (VAR)model. The third objective of the study is to find out the role of asset in Indian inflation. Our main motive of this study is to identify all the possible sources that contribute to Indian inflation. To identify the role of asset price in Indian inflation, first we have added asset price into the commodity basket by assigning weightage to it. To assign weightage to the asset prices in commodity baskets, we use Neo-Edgeworthian Index. Finally, after assigning weights we use Kalman filter to estimate the forecasted inflation from both headline series of inflation and also from the inflation series including asset prices. Final and last objective of this study is to find out whether targeting core inflation really improving the macroeconomic performance of India or not. The ultimate objective of every country is to achieve economic growth and a stable economy. After identifying all the possible factors that are contributing to Indian inflation then, the study aims to find whether adopting inflation targeting framework improves macroeconomic performance of the country or not. To empirically analyse this we use Vector Error Correction Model (VECM). We have also applied Impulse Response Function (IRF) to know how macroeconomic variables respond to any changes in core inflation.<br/>As a result, we find that SVAR is a good measure to estimate core inflation but practically using it is difficult. But if we will see practical applicability of the measures then trimmed mean measure is better one. The study also finds that trimmed mean measure is performing better than the other two measure of core inflation. The study compares the performance of core inflation estimated from both the WPI and combined CPI but the result shows that trimmed mean measure of core inflation estimated from combined CPI outperform than trimmed mean measure of core inflation estimated from WPI inflation. While analysing the dynamic relationship between headline and core inflation, our result supports the findings of the previous studies that the speed and direction of adjustment between headline and core inflation depends on the different monetary regime. Any unexpected changes in the monetary policy affect consumer behaviour and also price level before consumers start considering rational expectation. In case of India we see that trimmed mean measure is giving better result than non-food manufacturing product measure and also holding the definition of core inflation. External shocks have an immediate effect on tradable inflation as it directly associates with external economy, while it takes time to affect the non-tradable inflation, as it affects the non-tradable sectors in the second round effect. Core inflation is estimated by excluding volatile goods from the consumption basket, but this volatility of the commodities may not be due to its nature of the commodity, rather be because of external shocks. Excluding these commodities does not fully extract the temporary fluctuations; there may be an existence of second round effect of external shocks in the core inflation. We also find that considering gold as commodity of consumption basket helps in predicting better level of inflation. But here the problem is that, asset prices are highly fluctuating; they are more volatile than the items in normal consumption baskets of individuals. So, we cannot react to all the movements of asset prices. If any movements in asset prices signals any inflationary or deflationary situation then, only monetary policy must react to asset price movements. That means we have to find out the misalignments of asset prices. After identifying all the possible factors that are contributing to Indian inflation we aim to find the impact of four different measures of core inflation on the macroeconomic performance of India. Except non-tradable inflation all other three measures of inflation highly affect the REER. In case of net trade also only CPI with gold is highly affecting the net trade. In response to the shock to all the measure of core inflation IIP reacts in a cyclical manner. Call money rate is also highly responsive to the shock of trim core inflation and CPI with gold.
Topical Term Humanities & Social Sciences
Topical Term Financial Economics
Personal name Sethi, Narayan
Relator term Supervisor
Corporate name or jurisdiction name as entry element Department of Humanities & Social Sciences
Uniform Resource Identifier
Koha item type Thesis (Ph.D/M.Tech R)
Withdrawn status Damaged status Collection code Permanent Location Current Location Shelving location Date acquired Accession Number Koha item type
    Reference BP Central Library BP Central Library Thesis Section 29/11/2017 T651 Thesis (Ph.D/M.Tech R)

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