Consumer price index more relevant for policy: RBI study

Volatility in WPI inflation due to supply shocks makes it less effective.

A study by Reserve Bank of India staffers has favoured updating the price statistics, particularly consumer price, to improve the effectiveness of monetary policy.

The large divergence between Consumer Price Inflation (CPI) and Wholesale Price Inflation (WPI) trends, and significant volatility in headline WPI inflation due to supply shocks limit the use of price data for monetary policy making.

The Indian inflation path has been significantly conditioned by two major supply shocks — oil and food. The common man is primarily affected by these two items. Hence, exclusion of these two items will make measurement of core inflation less representative, it said. The CPI captures the effects of a rise in oil and food prices more accurately at the customer end, some analysts say.

RBI on Thursday released a staff study ‘Measurement of Inflation in India, Issues and Associated Challenges for the Conduct of Monetary Policy’.

The authors, G V Nadhanael and Sitikantha Pattanaik, said year-on-year inflation has been much less volatile than the sequential month over month (seasonally adjusted) inflation. Hence, the former is more relevant for conduct of monetary policy.

A wide dispersion in inflation across commodity groups within WPI and the weakly representative nature of price indices also complicate matters, the study said.

In the Indian context, measures like month-over-month seasonally adjusted inflation and core inflation are significantly volatile. Hence, they can’t become the key reference indicators in monetary policy, it said.

The share of significantly volatile items like, fuel and metals in total transactions have increased over time.

The distribution of inflation across different commodities within the WPI exhibits large changes during supply shocks. Understanding the variability within the commodity basket is critical to analyse the underlying price pressures and respond with appropriate policy action.