Inflation convergence and anchoring of expectations in India

Careful research on the inflation targeting regime's impact on anchoring inflation expectations as well as an empirical examination of convergence is used to assess the direction of convergence between core and headline inflation as well as the efficacy of the expectation channel compared to the aggregate demand channel of monetary transmission. There is evidence of more anchoring, with RBI communications as well as headline inflation affecting short-run inflation expectations and core inflation dominating in the long-run. The Repo rate has hardly any affect. While persistently high headline affects core, normally a volatile headline reverts to a more stable core. Transitory shocks to components of core have kept it sticky, but it is also softening, so that both core and headline can be expected to approach the inflation target. Our evidence supports the expectation channel of monetary transmission to inflation but not the aggregate demand channel. It follows monetary policy should focus on clear communication and accurate forecasts, while avoiding excessively high policy rates.