According to the report, cross-country studies show higher forecast errors when share of food is high in the CPI (Consumer Price Index).
The case-in-point is the retail inflation projections from April 2015 to September 2018 which had shown two periods of large projection errors associated with unanticipated sharp fall in food inflation, especially in veggies.
Under the present policy framework, inflation forecasts are critical for the conduct of forward-looking monetary policy as they play a special role in an inflation targeting framework by acting as an intermediate target.
Hence, the significance of accurate forecasts can hardly be overemphasised, said the report.
The bi-monthly resolutions of the MPC of the RBI provide inflation forecasts for up to four quarters ahead.
The Monetary Policy Report (MPR), released twice in a year (April and October), provides inflation forecasts for up to eight quarters ahead.
Inflation forecasts were also an integral part of monetary policy communication even before the adoption of the flexible-inflation targeting framework in 2016, but they assumed a special significance under the FIT regime.
As per the report, the CPI inflation projections from April 2015 to September 2018 shows two periods of large projection errors associated with unanticipated sharp fall in food inflation, especially in veggies.
An examination of the CPI inflation projections in India during April 2015 to September 2018 showed two periods of large projection errors, -- October 2016 to March 2017 and June-September 2018.
Both episodes were associated with unanticipated sharp fall in food inflation particularly in case of perishables, stated the report titled "Inflation Forecasts: Recent Experience in India and a Cross-country Assessment".
The analysis also indicates that globally, since the 2008 financial crisis, a phenomenon of over prediction has been observed, with actual inflation undershooting forecasts.
In the case of India, the mean forecast error was somewhat negative (actual inflation undershot the inflation forecasts). Including the period of demonetisation, bias in the forecast errors turns out to be statistically significant.
The forecasts by the RBI staff have been by and large efficient, though there have been deviations of actual inflation from the forecasts.
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