Economics Journals| Applied Economics

The IUP Journal of Applied Economics

Food and Fuel Inflation: Is There a Threshold That Unanchors Inflation Expectations?

Article Details

Pub. Date	: Jan, 2023
Product Name	: The IUP Journal of Applied Economics
Product Type	: Article
Product Code	: IJAE030423
Author Name	: Sangita Misra, Aastha and Misha Sood
Availability	: YES
Subject/Domain	: Economics
Download Format	: PDF Format
No. of Pages	: 24

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Abstract

This paper evaluates the relationship between supply-driven components of India's inflation and inflation expectations as derived from the Reserve Bank of India's Inflation Expectations Survey of Households (IESH). To be precise, it determines a threshold level for 'food' and 'combined food and fuel' CPI inflation rate beyond which the inflation expectations start getting de-anchored. The novelty of this study lies in throwing light on the timing of central bank intervention in episodes of supply side inflation with an objective to anchor inflation expectations. The estimation is carried out by using quarterly time series data on inflation and inflation expectations from 2012 to 2022. The results obtained in the study suggest the existence of a inflation threshold level for food at 7-7.5% and for combined food and fuel at 6.5%.

Introduction

Implementation of the Flexible Inflation Targeting (FIT) framework by the Reserve Bank of India (RBI) in 2016 mandated to keep the inflation rate around its target of 4% (+_2%). Adoption of this framework, on the one hand, has enhanced credibility of the central bank in controlling inflation and, on the other hand, has put greater accountability on the shoulders of the central bank in keeping inflation under check and inflation expectations well anchored. This is critical as expectations can influence the actual inflation in the economy in more than one way. Households, if they expect inflation to go up, will adjust their behavior to deal with the situation by demanding higher price markups, negotiating for higher wages, rent, transportation costs and prices of personnel services like housekeeping, medical and education fees (Patra, 2022) (Figure 1). With the households accounting for almost 60% of India's Gross Domestic Product (GDP) through private consumption expenditure, inflation

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