The Reserve Bank of India said it has revised its inflation forecasting model to better understand how fiscal and monetary policy interacts with elements of the real economy. The adjustments incorporate fiscal and monetary dynamics, India’s unique and often chaotic fuel pricing regime, as well as exchange rate fluctuations and their impact on the balance of payments, the Reserve Bank of India said in its statement. latest semi-annual monetary policy report released on Wednesday.
Dubbed the Quarterly Projection Model 2.0, RBI economists describe the framework as a new-Keynesian, future-oriented, open-economy, calibrated gap model. The previous version was often criticized for overestimating the upside risks to inflation.
The changes come just days after the RBI gained government approval to keep its inflation target range of 2 to 6 percent for the next five years. He did not offer a comparison between the expected inflation rates in the previous model and the new model, but said his tools helped him keep inflation anchored around the midpoint of 4% on average in the past. over the past five years.
The RBI said the new model is divided into three blocks:
- The first, or budget block, breaks down the government’s primary deficit into structural and cyclical components. A shock on the former has an impact on inflation via aggregate demand and country risk premiums; for example, a structural increase in the deficit would create a positive output gap, and higher debt makes borrowing more expensive and depreciates the currency, resulting in higher inflation. Cyclical shock is negligible
- The second, or fuel block, takes into account India’s complex pricing system. The prices of items like gasoline and diesel are calculated on the basis of international oil prices, exchange rates and local taxes, while the prices of liquefied petroleum gas and kerosene are determined by the market but with deferred impact. Electricity costs are managed by state governments. Headline inflation rises 25 basis points in response to an increase in the fuel tax of 10 rupees (13 cents) per liter, the RBI said.
- The balance of payments block recognizes the costs associated with surges in exchange rate volatility. In a capital outflow shock of 1% of GDP, and assuming the RBI steps in and sterilizes 70% of those outflows, reserves will run out by 0.7% of GDP and the exchange rate will depreciate, causing inflationary pressure
“This is an attempt to align the RBI’s inflation forecasting model with the country’s exchange rate regime, which is essentially a managed float,” said Rohan Chinchwadkar, assistant professor of finance. to Shaliesh J. Mehta School of Management at IIT, Mumbai, in a Twitter post.
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