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Modeling heterogeneity and rationality of inflation expectations across Indian households

Author

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  • Ashima Goyal

    () (Indira Gandhi Institute of Development Research)

  • Prashant Parab

    (Indira Gandhi Institute of Development Research)

Abstract

We analyze the inflation expectation formation of Indian Households using Inflation Expectations Survey of Households dataset, and draw out its implications for the effectiveness and use of the expectations channel of monetary policy transmission. Using quantitative responses we discover that households' expectations are adaptive and backward looking. They are not efficient. Food inflation has a significant short run impact but the effect of core inflation increases over the long run. There is considerable heterogeneity across households with females, daily workers, young and retired persons having higher inflation expectations than their counterparts. Unlike advanced economies, retired persons have higher expectations perhaps due to the accumulated information about higher inflation in the past, inadequate social security and underdeveloped pension schemes. Households do not overreact in comparison to the forecasts of RBI and professional forecasters. But short term reactions are significant and heterogeneous across households. The large speed of adjustment, absence of over-reaction, low response coefficients to commodity shocks in a simultaneous and impact of the RBI's forecasted path bodes well for successfully anchoring household inflation expectations in the process of inflation targeting, but requires that these forecasts are carefully made with a focused use of the expectations channel. Communications have more of an impact on inflation expectations than the interest rate. A repo rise actually raises inflation expectations pointing to the ineffectiveness of the aggregate demand channel and of aggressive rate rises.

Suggested Citation

  • Ashima Goyal & Prashant Parab, 2019. "Modeling heterogeneity and rationality of inflation expectations across Indian households," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2019-02, Indira Gandhi Institute of Development Research, Mumbai, India.
  • Handle: RePEc:ind:igiwpp:2019-02
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    File URL: http://www.igidr.ac.in/pdf/publication/WP-2019-002.pdf
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    References listed on IDEAS

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    1. Easaw Joshy & Golinelli Roberto, 2010. "Households Forming Inflation Expectations: Active and Passive Absorption Rates," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-32, November.
    2. Easaw, Joshy & Golinelli, Roberto & Malgarini, Marco, 2013. "What determines households inflation expectations? Theory and evidence from a household survey," European Economic Review, Elsevier, vol. 61(C), pages 1-13.
    3. Martin Cerisola & Gaston Gelos, 2009. "What drives inflation expectations in Brazil? An empirical analysis," Applied Economics, Taylor & Francis Journals, vol. 41(10), pages 1215-1227.
    4. Rahul Anand & Ding Ding & Volodymyr Tulin, 2014. "Food Inflation in India; The Role for Monetary Policy," IMF Working Papers 14/178, International Monetary Fund.
    5. Bhattacharya. Rudrani, 2017. "Effectiveness of monetary policy in stabilising food inflation: Evidence from advanced and emerging economies," Working Papers 17/209, National Institute of Public Finance and Policy.
    6. Olivier Coibion & Yuriy Gorodnichenko, 2015. "Information Rigidity and the Expectations Formation Process: A Simple Framework and New Facts," American Economic Review, American Economic Association, vol. 105(8), pages 2644-2678, August.
    7. Malka de Castro Campos & Federica Teppa, 2016. "Individual inflation expectations in a declining-inflation environment: Evidence from survey data," DNB Working Papers 508, Netherlands Central Bank, Research Department.
    8. Jan Marc Berk, 1999. "Measuring inflation expectations: a survey data approach," Applied Economics, Taylor & Francis Journals, vol. 31(11), pages 1467-1480.
    9. Michael Ehrmann & Damjan Pfajfar & Emiliano Santoro, 2017. "Consumers' Attitudes and Their Inflation Expectations," International Journal of Central Banking, International Journal of Central Banking, vol. 13(1), pages 225-259, February.
    10. repec:eee:intfor:v:35:y:2019:i:3:p:980-993 is not listed on IDEAS
    11. Das, Abhiman & Lahiri, Kajal & Zhao, Yongchen, 2019. "Inflation expectations in India: Learning from household tendency surveys," International Journal of Forecasting, Elsevier, vol. 35(3), pages 980-993.
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    More about this item

    Keywords

    Inflation expectations of households; rationality; heterogeneity; anchoring; inflation targeting; central bank communication;

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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