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Business News/ Market / Mark-to-market/  How successful has Raghuram Rajan been in reducing inflation expectations?
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How successful has Raghuram Rajan been in reducing inflation expectations?

Inflation expectations, CPI have fallen quite a bit from September 2013 when Raghuram Rajan, took over as RBI governor, but higher than December 2014 numbers

Graphic: Ajay Negi/MintPremium
Graphic: Ajay Negi/Mint

Perhaps Reserve Bank of India (RBI) governor Raghuram Rajan’s most important policy effort has been to lower the very high inflation expectations in the Indian economy. He has said that monetary policy “works" by containing the public’s inflation expectations. Years of rapidly rising prices have led to these expectations remaining stubbornly elevated, in spite of a steep fall in the Consumer Price Index (CPI)-based inflation.

The accompanying chart gives the three-month ahead median household inflation expectations from the RBI quarterly survey, together with CPI inflation. As we can see, both have fallen quite a bit from September 2013, when Rajan took over the reins at the central bank.

But a closer look shows that inflation expectations are higher now than they were in the December 2014 quarter. Why did that happen? The CPI inflation provides a clue. As the chart shows, CPI inflation fell to a low 4.5% in the December 2014 quarter and that perhaps led to a concomitant plunge in household inflation expectations too. Surprisingly though, a similar decline in the pace of inflation in the September 2015 quarter didn’t lead to lower inflation expectations.

Could it be because RBI was lowering its policy rate in 2015 and that led to concerns about whether inflation would spike higher? Or was it the drought that led to people worrying that food prices would remain elevated? Whatever the reason, we may reasonably conclude that inflation needs to stay low for a long period of time in order to break the back of persistently high inflation expectations.

Note also that inflation expectations have risen in the June quarter, as inflation has gone up once again. In short, the history of the Rajan years at the central bank suggests that it would be prudent for the next RBI governor and the new monetary policy committee to be very cautious about any reduction in the policy rate, particularly as economic recovery gathers steam.

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Published: 10 Aug 2016, 02:48 AM IST
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