DETERMINANTS OF INFLATION IN INDIA.

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Authors: Pami Dua and Deepika Goel
Date: Spring 2021
From: Journal of Developing Areas(Vol. 55, Issue 2)
Publisher: Tennessee State University
Document Type: Article
Length: 6,819 words
Lexile Measure: 1430L

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Abstract :

This paper examines the drivers of overall inflation and its component, food inflation in India using monthly data from April 1996 to March 2017. The analysis covers both WPI and CPI-IW measures of inflation along with their component food inflation. The study uses cointegration approach to identify the determinants of inflation in India. Empirical estimates of the study show that there is a long-run relationship between inflation and its determinants that include expected inflation, output gap, rate of growth of money supply, exchange rate, interest rate, fiscal deficit, minimum support prices, rainfall international oil and food prices. These determinants also Granger cause both the measures of inflation. The normalised generalised variance decompositions suggest that determinants of inflation, in descending order of importance include expected inflation, exchange rate, rate of growth of money supply and output gap and least variation in them is explained by interest rates. This analysis is found to be similar for both the measures of inflation. Thus demand factors such as exchange rate, rate of growth in money supply and output gap explain significant variation in both the measures. On the supply side global factors like international oil and food prices play a key role in determining both overall and food inflation in the economy. This has important policy implications in the light of new monetary framework where flexible inflation targeting is adopted by the central bank. Inflation management will become a more challenging task as inflation is also significantly determined by the supply side variables. The Reserve Bank of India's report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (ECRSMPF) reports that monetary policy has little or no effect on food and fuel inflation, which are the supply side factors. The report also finds that high inflation in food and fuel with strong secondary effects gets generalised in the system through inflation expectations. Shocks to food and fuel inflation have a high degree of persistence on household inflation expectations which leads to more prolonged effects on headline inflation. Hence, for better management of inflation dynamics, an analysis of the driving factors can help predict likely changes in inflation more efficiently and accurately. JEL Classifications: E31, E64, Q18 Keywords: NKPC, Demand and Supply side factors, Overall and Food Inflation, Wholesale and Consumer Price Inflation, Vector Error Correction Model (VECM), Granger causality, Forecast Error Variance Decomposition Corresponding Author's Email Address: deepika_goel@hotmail.com

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Gale Document Number: GALE|A641753916