ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Persistence and Volatility-weighted Measures of Core Inflation for India

Unlike exclusion-based measures which remove food and fuel entirely from core inflation, the proposed core measures, using alternative weighting schemes, assign higher weight to the more persistent and less volatile groups in both food and non-food components to capture the more durable part of inflation. We show that our constructed indices satisfy the common properties of core inflation as (i) an unbiased estimate, (ii) a smoother and persistent component, and (iii) a good predictor of headline inflation, thus providing an alternative gauge of underlying inflation.

Central banks have a keen interest in core or underlying inflation as a signal of the medium-term trajectory of inflation. Given its importance for inflation dynamics, central banks emphasise on the evolution of core inflation in their communication with many of them publishing their official measures of core inflation (Ehrmann et al 2018; Ha et al 2019). Globally, the pandemic and the war have propelled inflation to multi-decadal highs, raising concerns of an inflationary spiral and bringing core inflation into focus in monetary policy decisions.

Broadly, core inflation can be measured using two methodsstructural,1 that is, based on economic theory, and statistical, that is, based on the distribution of price changes. Central banks, however, mostly rely on measures that exclude items such as food and energy that exhibit high volatility in prices. Considering the long and variable lags in the impact of monetary policy on output and inflation, transitory shocks in these prices are overlooked and the focus remains squarely on core or underlying inflation. Thus, core inflation works as an operational guide for monetary policy decisions and communication (Mishkin 2007).

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Published On : 9th Mar, 2024

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