RBI Working Paper Finds A Steady Decline In Trend Inflation In Recent Years

There has been a steady decline in trend inflation in India, the Reserve Bank of India noted in a Working Paper titled "Measuring Trend Inflation in India". The Paper is authored by Harendra Kumar Behera and Michael Debabrata Patra. Central to the design and conduct of monetary policy is the concept of trend inflation, the level to which actual inflation outcomes are expected to converge after short run fluctuations from a variety of sources die out. The paper seeks to estimate trend inflation in India to find the answer to a question that goes to the root of flexible inflation targeting (FIT) - is the choice of the target for inflation consistent with its trend?

The paper finds a steady decline in trend inflation to 4.1- 4.3% since 2014. A target set too below the trend imparts a deflationary bias to monetary policy because it will go into overkill relative to what the economy can intrinsically bear in order to achieve the target. Analogously, a target that is fixed above trend renders monetary policy too expansionary and prone to inflationary shocks and unanchored expectations. Hence, maintaining the inflation target at 4% is appropriate for India.

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