“Understanding Inflation in India”

by
Laurence Ball, Anusha Chari and Prachi
Mishra

Comments by
Kenneth Kletzer
IPF 2015
 About the paper

• This is a valuable contribution to the analysis and

discussion of inflation in India.
• It is clear and concise.
• In particular, the paper applies a well accepted
approach for the US and other advanced economies
to the measurement of core inflation and the sources
of short-run inflation volatility for India.
 Core inflation
• Short-run inflation is significantly more volatile than
trend inflation.
• Defining core inflation is an attempt to remove high
frequency fluctuations in nominal prices from
persistent inflation.
• The distinction between core and headline inflation is
motivated by the classical dichotomy between the
monetary and real sides of the economy.
• Trend inflation ought to be due to monetary
phenomenon only. With nominal rigidities, short-run
changes in the price level can arise from non-monetary
sources. Of course, short-run inflation volatility can
also be caused by monetary policy.
 Measuring core inflation
• Limited influence estimators (eg. trimmed means or
median) remove transitory effects of the tails of
skewed distributions of price changes (Bryan and
Cecchetti (1995)).
• Assuming menu costs, unexpected price changes are
made by firms that experience large shocks (Ball and
Mankiw (1995)).
• Differences between mean and median inflation tend
to be transitory.
• Limited influence estimators and econometric
approaches (eg. Quah and Vahey (1995)) are preferable
to ad hoc measures, such as “all items less food and
energy.”
 Core inflation in India

• Ball, Chari and Mishra illustrate the difference between

weighted median and weighted mean inflation in
Figure 2 and show that food and fuel contribute
significantly to upper tail price changes.
• Limited influence estimators have been advocated for
India before (eg. Mohanty, Rath and Ramaiah (2000)).
• The second part of the paper uses the weighted
median to estimate the contribution of real activity to
inflation using the Friedman-Phelps Phillips curve.
• Inflation expectations are backward looking in this
model.
 Phillips curve regressions
• The authors estimate Phillips curves with core inflation
and headline inflation against the quarterly output gap.
• The implicit price-setting model suggests using a PPI,
rather than CPI. The WPI is an imperfect substitute, but
it’s the best they have.
• The authors point out weaknesses in the data,
although their suspicions about the smoothness of the
quarterly GDP data could be investigated and
discussed.
• The results show that a Phillips curve for India fits the
data using median inflation.
• Aggregate supply shocks are taken out of the equation
by replacing actual inflation by core inflation.
• The reported regressions show that expectations can
be represented by either lagged median or headline
inflation.
• That is, cost shocks come in through headline inflation
in regression 3 of Table 3.
• Regression 2 is noted as mis-specified. It is missing cost
shocks, the third variable in the standard
accelerationist Phillips curve.
• The analysis is based on a menu costs model of price
setting.
• It may be helpful to repeat the PC estimation in Ball
and Mankiw (1995) of inflation on expected inflation,
output gap, and skewness interacted with the variance
of inflation.
• An alternative approach is the estimation of a new
Keynesian Phillips curve (Anand, Ding and Tulin (2014)
estimate a NK model for India in a recent IMF paper).
 Critique

• This paper ends by offering its evidence in favor

of using the weighted median measure of core
inflation for India.
• But is that enough? The title “Understanding in
India” promises more.
• The persistence of inflation in India has fostered
substantial debate over monetary policy and non-
monetary sources of inflation.
• Having a measure of trend inflation in hand, it
makes sense to apply it.
 Persistence of inflation in India
• Much discussion has focused on the influence of food
and energy price increases and non-monetary
interventions on inflation (eg. MSP).
• How do deviations between food and fuel inflation
from core inflation play out over time?
• Headline inflation and core inflation converge following
shocks to food and fuel prices (Anand, Ding and Tulin
(2014) find that 75% of a gap closes in a year).
• Food and fuel inflation often persists and shocks to
commodity prices tend to lead to increases in core
inflation.
• The results in the paper tells that (i) upper tail
prices changes are important, and (ii) inflation
depends on real economic activity.
• One wonders whether supply shocks lead to
inflation persistence because of monetary
accommodation.
• The stickiness in inflation comes through
backward-looking expectations that discount the
past slowly.
• As a next stage, it would be good to look at how
supply shocks future core inflation.
 Policy implications for now

• The conclusion that inflation in India compares to

inflation in the 1970s in advanced economies is
informative.
• As elsewhere, reforms (such as those explored in
the Patel report) leading to anchored
expectations may also lead to taming Indian
inflation.
• I look forward to reading the authors’
interpretation of what it means for policy making
for some characteristics of inflation look like the
1970s in the US.