Flexible inflation targeting helps anchor inflation expectations: RBI study

RBI's report on the transition to flexible inflation targeting highlights its role in managing inflation expectations, despite supply shocks and global inflation factors

The transition to flexible inflation targeting (FIT) regime has helped in anchoring inflation expectations, a study authored by the Reserve Bank of India (RBI) staff noted. The study was released in July’s bulletin.

 

According to the study, Indian households’ inflation expectations remain elevated even in periods of price stability, compared to those of professionals.

 

Demographic factors such as gender, age, and professional background play significant roles in inflation expectations. Notably, men, older individuals (45 and above), self-employed, and daily workers, who often operate on variable incomes, exhibit higher inflation expectations, the study said. In contrast, younger and salaried individuals are more attuned to realised inflation dynamics, likely reflecting their exposure to financial and social networks.

 

 

The study highlighted that transition to the FIT regime along with timely fiscal interventions, such as export bans and lower import duties, and moderating inflation levels has contributed to decline in the levels of expectations. 

 

However, supply shocks and global inflation shocks, induced by the pandemic and geopolitical tensions, have elevated inflation expectations, particularly across headline, food and housing categories, the study said. It added that high food inflation during periods of high inflation may keep the expectations elevated, even as headline matters more for inflation expectations. “Nonetheless, most recently, as inflation has been showing signs of easing, expectations of households have also come down,” the study said.

 

It also highlighted that macroeconomic shocks, especially volatility of food price, play a prominent role in influencing short-term (up to one-year ahead) household expectations, especially during adverse weather conditions.

 

While households may rely on personal perceptions and economic conditions in the short term, they give greater weight to inflation history (life experiences) and monetary policy in the long term, highlighting the critical role of policy in anchoring inflation expectations, the report noted.