Artha Vijnana: Journal of The Gokhale Institute of Politics and Economics

Open Access Open Access  Restricted Access Subscription Access
Open Access Open Access Open Access  Restricted Access Restricted Access Subscription Access

Inflation Dynamics and Impact of Demand and Supply Shocks:Evidence from India


Affiliations
1 School of Economics, University of Hyderabad, Hyderabad 500046, Telagana, India
     

   Subscribe/Renew Journal


This present article tries to comprehend the dynamics of inflation with respect to both core and headline measures of inflation. To understand the dynamic movement in both the measures of inflation, first core inflation is calculated using the traditional exclusion measure (excluding food and energy), and statistical measure using the trimmed mean approach by considering monthly Combined Consumer Price Index (CPI) y-o-y cross-sectors headline distribution of data from January 2012 and December 2018. Next, a comparative study is attempted to know the reaction of both core and headline inflation measures to different demand and supply shocks by the Structural Vector Autoregressive Techniques.

Based on empirical analysis, it is proved that 20 per cent trimming of the extremely volatile components from the headline inflation can be considered as a better proxy for core inflation series. Core inflation series by trimming 20 per cent has the better predictive ability for the underlying trend in the overall inflation. In addition, empirical findings further show that core inflation is more responsive to demand shocks, suggesting that core inflation is mostly affected by real economic activity whereas the fluctuation in headline inflation, on the other hand, is more explainable by supply side factors in India. It is much more volatile. Thus, considering headline inflation in the decision making process of the monetary policy in the determination of policy rates can contribute to biasness and hence affect the long term objective of inflation targeting. Variations in core inflation are more observed due to monetary policy behaviour and hence making it an important component in the policy decision making.


Subscription Login to verify subscription
User
Notifications
Font Size

  • Alkhareif, R.M. and W.A. Barnett (2015), Core Inflation Indicators for Saudi Arabia, Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, 62(3): 257–266.

  • Ball, L. and N.G. Mankiw (1995), Relative-price Changes as Aggregate Supply Shocks, The Quarterly Journal of Economics, 110(1): 161-193.233

  • Bashar, O.H. (2011), Measuring Core Inflation in Bangladesh: An Unobserved Components Approach, Indian Economic Review, 46(1): 109-129.

  • Baxter, M. and R.G. King (1999), Measuring Business Cycles: Approximate Band-pass Filters for Economic Time Series, Review of Economics and Statistics, 81(4): 575-593.

  • Berkmen, P. (2002), Measuring Core Inflation for Turkey-trimmed Means Approach, Central Bank Review, 2(2): 1-18.

  • Bernanke, Ben S. (2007), Inflation Expectations and Inflation Forecasting, Monetary Economics Workshop of the National Bureau of Economic Research Summer Institute, Cambridge, Mass.

  • Blinder, A. and R. Reis (2005), Understanding the Greenspan Standard in Federal Reserve Bank of Kansas City, The Greenspan Era: Lessons for the Future, Proceedings of the 2005 Jackson Hole Symposium (pp. 11–96).

  • Blix, M. (1995), Underlying Inflation: A Common Trends Approach, Sveriges Riksbank Arbetsrapport Nr 23.

  • Bodenstein, M., C.J. Erceg and L. Guerrieri (2008), Optimal Monetary Policy with Distinct Core and Headline Inflation Rates, Journal of Monetary Economics, 55(supplement): s18–s33.

  • Bryan, M.F. and C.J. Pike (1991), Median Price Changes: An Alternative Approach to Measuring Current Monetary Inflation, Federal Reserve Bank of Cleveland Economic Commentary, 1.

  • Bryan, M.F. and S.G. Cecchetti (1994), Measuring Core Inflation, In Monetary policy Chicago: The University of Chicago Press, pp. 195-219.

  • Cecchetti, S.G. (1996), Measuring Short-run Inflation for Central Bankers, Working paper 5786. National Bureau of Economic Research.

  • Clark, T. (2001), Comparing Measures of Core Inflation, Federal Reserve Bank of Kansas City Economic Review, 86(2): 5–31.

  • Cogley, T. (2002), A Simple Adaptive Measure of Core Inflation, Journal of Money, Credit, and Banking, 34(1): 94–113.

  • Das, A., J. John and S. Singh (2009), Measuring Core Inflation in India, Indian Economic Review, 44(2): 247-273, new series.

  • Dixon, R. and G.C. Lim (2004), Underlying inflation in Australia: Are the Eexisting Measures Satisfactory?, Economic Record, 80(251), 373-386.

  • Dolmas, J. (2005), Trimmed Mean PCE Inflation, Working Paper 0506, Federal Reserve Bank of Dallas.

  • Donkers, H.W., J. Bjerregaard Jensen, J. Hyrkkö, I. Lehtinen, D.C. Murphy, G. Stolpe and R. Turvey, (1983), Adjusting the CPI for Indirect Taxes, Bulletin of Labor Statistics, 4(0): 26-30.

  • Eckstein, Otto. (1981), Core Inflation, Englewood Cliffs, N.J.: Prentice-Hall.

  • Fase, M.M.G. and C.K. Folkertsma (1996), Measuring Inflation: An Attempt to Operationalize Carl Menger's Concept of the Inner Value of Money, De Nederlandsche Bank Staff Reports No. 8.

  • Figueiredo, F. M.R. and R.B. Staub (2002), Evaluation and Combination of Core Inflation Measures for Brazil, Central Bank of Brazil, Research Department.

  • Gamber, E.N., J.K. Smith and R. Eftimoiu (2015), The Dynamic Relationship between Core and Headline Inflation, Journal of Economics and Business, 81(7): 38–53.

  • Johansen, S. (1991), Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models, Econometrica, 59(6): 1551-1580.

  • ---------- (1995), A Statistical Analysis of Cointegration for I (2) Variables, Econometric Theory, 11(1): 25-59.

  • Johnson, J. (1999), Core Inflation: A Measure of Inflation for Policy Purposes, Proceedings of the workshop of central bank model builders - Measures of Underlying Inflation and their Role in the Conduct of Monetary Policy Bank of International Settlements, pp. 18-19.

  • Kar, S. (2009), Statistical Tools as Measures of Core Inflation for India, Indian Economic Review, 44(2): 225-245.

  • Kiley, M.T. (2008), Estimating the Common Trend Rate of Inflation for Consumer Prices and Consumer Prices Excluding Food and Energy Prices, Divisions of Research and Statistics and Monetary Affairs, Federal Reserve Board.

  • Knotek, Edward S. and Saeed Zaman (2017), Nowcasting US Headline and Core Inflation, Journal of Money, Credit and Banking, 49(5): 931-968.

  • Laflèche, T. and J. Armour (2006), Evaluating Measures of Core Inflation, BoC Review, pp. 19-29, September.

  • Marques, C.R., P.D. Neves and L.M. Sarmento (2003), Evaluating Core Inflation Indicators, Economic Modelling, 20(4): 765–775.

  • Mishkin, F.S. (2007), Headline versus Core Inflation in the Conduct of Monetary Policy, Business Cycles, International Transmission and Macroeconomic Policies Conference, HEC Montreal, Montreal, Canada.

  • Mohanty, D., D.P. Rath and M. Ramaiah (2000), Measures of Core Inflation for India, Economic and Political Weekly, 35(5): 273–282.

  • Quah, D. and S.P. Vahey (1995), Measuring Core Inflation, The Economic Journal, 105(432): 1130–1144.

  • Raj, J. and S. Misra (2011), Measures of Core Inflation in India – An Empirical Evaluation, Reserve Bank of India, Department of Economic and Policy Research, Working Paper 16.

  • Rather, S.R., S.R.S. Durai and M. Ramachandran (2016), On the Methodology of Measuring Core Inflation, Economic Notes: Review of Banking, Finance and Monetary Economics, 45(2): 271-282.

  • Rich, R.W. and C. Steindel (2005), A Review of Core Inflation and an Evaluation of Its Measures, Federal Reserve Bank of New York Staff Reports, no. 236

  • Roger, S. (1998), Core Inflation: Concepts, Uses and Measurement, Reserve Bank of New Zealand Discussion Paper, (G98/9).

  • Sahu, P. and N.K. Sharma (2018), Core Inflation Dynamics and Impact of Demand and Supply Shocks: Evidence from India, In: Mishra A., Arunachalam V., Patnaik D. (Eds), Current Issues in the Economy and Finance of India, ICEF 2018, (pp. 3-25) Springer Proceedings in Business and Economics, Springer, Cham.

  • Shrestha, P.K. (2006), Some Measures of Core Inflation and their Evaluations in Nepal, NRB Economic Review, 18: 37-69.

  • Smith, J. (2005), Inflation Targeting and Core Inflation, The Canadian Journal of Economics, 38(3): 1018-1036.

  • Stock, J.H. and M.W. Watson (2016), Core Inflation and Trend Inflation, Review of Economics and Statistics, 98(4): 770-784.

  • Wynne, M. (1999), Core Inflation: A Review of Some Conceptual Issues, European Central Bank (ECB) Working Paper No. 5, 1-23.


Abstract Views: 771

PDF Views: 2




  • Inflation Dynamics and Impact of Demand and Supply Shocks:Evidence from India

Abstract Views: 771  |  PDF Views: 2

Authors

Priyanka Sahu
School of Economics, University of Hyderabad, Hyderabad 500046, Telagana, India

Abstract


This present article tries to comprehend the dynamics of inflation with respect to both core and headline measures of inflation. To understand the dynamic movement in both the measures of inflation, first core inflation is calculated using the traditional exclusion measure (excluding food and energy), and statistical measure using the trimmed mean approach by considering monthly Combined Consumer Price Index (CPI) y-o-y cross-sectors headline distribution of data from January 2012 and December 2018. Next, a comparative study is attempted to know the reaction of both core and headline inflation measures to different demand and supply shocks by the Structural Vector Autoregressive Techniques.

Based on empirical analysis, it is proved that 20 per cent trimming of the extremely volatile components from the headline inflation can be considered as a better proxy for core inflation series. Core inflation series by trimming 20 per cent has the better predictive ability for the underlying trend in the overall inflation. In addition, empirical findings further show that core inflation is more responsive to demand shocks, suggesting that core inflation is mostly affected by real economic activity whereas the fluctuation in headline inflation, on the other hand, is more explainable by supply side factors in India. It is much more volatile. Thus, considering headline inflation in the decision making process of the monetary policy in the determination of policy rates can contribute to biasness and hence affect the long term objective of inflation targeting. Variations in core inflation are more observed due to monetary policy behaviour and hence making it an important component in the policy decision making.


References





DOI: https://doi.org/10.21648/arthavij%2F2019%2Fv61%2Fi3%2F185875