Are all movements in food and energy prices transitory? Evidence from India

This paper seeks to answer two questions in the context of the Indian economy. First, are all movements in food and energy prices transitory? Second, is there a significant relationship between permanent and transitory shocks to different components of the aggregate price level? Using monthly price data for India and a multivariate correlated unobserved component model based on Morley et al. ((2003). The Review of Economics and Statistics, 85(2): 235) and Bradley et al. (forthcoming), we find that both food and energy prices have significant permanent components. Further, we find a significant feedback effect between permanent components of food prices and manufacturing good prices. These findings suggest that neglecting food and energy prices may render the core inflation measure based solely on manufacturing prices a biased measure of long run inflation. Finally, using a forecasting experiment, we show that a measure of the trend inflation that explicitly accounts for long run price movements in food and energy prices provides a superior forecast of future inflation when compared with alternative measures of the trend inflation.