Reviewing core inflation measures in India

Janak Raj & Sangita Misra of RBI write this nice paper on the topic.

They look at a number of core measures of inflation in India and say current core inflation  measure of non-food manufacturing works the best.

This study attempts to analyse six exclusion-based measures of core inflation in India based on new series of WPI (2004-05=100). These are: WPI excluding food; WPI excluding fuel; WPI excluding food and fuel; non-food manufacturing; WPI excluding fuel and basic metals and metal products; and WPI excluding fuel, metal group and non-food primary articles. These measures were tested for volatility, unbiasedness and tracking the trend and predictive power. While WPI excluding food and WPI excluding food and fuel did not perform well in terms of volatility, the remaining four measures broadly satisfied the conditions relating to volatility, unbiasedness and tracking the trend and predictability of future inflation. A key property of core measure is that it should not revert to headline inflation.

It was found that of the above four measures, all except non-food manufacturing revert back to headline inflation indicating that supply side shocks spill over to these core measures of inflation. This finding was further corroborated by granger causality and inflation persistence tests. Thus, non-food manufacturing, which the Reserve Bank uses as a measure of demand side pressures, is the only measure which satisfies all the properties of a core measure. A core measure of inflation is not an end in itself, but rather a means to achieve low and stable inflation by serving as a short-term operational guide for monetary policy.




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