Household inflation expectations have subsided
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Mumbai: The Reserve Bank of India (RBI) has remained vigilant on the inflation front and resisted calls to lower interest rates. It delivered only a single rate cut in 2017, amounting to 25 basis points. Further cuts seem unlikely anytime soon as retail price inflation remains above RBI’s 4% target. Whether the stance of RBI is appropriate or not, given the subdued investment activity, remains a matter of debate. However, RBI’s policy has at least been successful in driving down household inflation expectations.
One basis point is one-hundredth of a percentage point.
People’s expectations of future inflation are important as they can help or impede RBI’s efforts in tackling inflation. To illustrate, workers and employees often negotiate their wage or salary keeping in mind expected inflation. Any fall in expected inflation can thus lead to a slower rise in wage costs for firms, translating into a slower rise in prices charged to customers.
Also, if inflation expectations are firmly anchored, then any temporary shocks to inflation would not persist for long, thereby making the task of monetary policy easy, as was noted in a recent column by Bhavesh Salunkhe and Anuradha Patnaik for Mint.
Thus, the fall in inflation expectations of households is a welcome development. Of course, there remain many reasons to be sceptical of RBI’s household survey on inflation expectations. The survey is confined to only 18 cities and ignores rural households. Moreover, the sample of households does not appear to be representative of the overall urban population.
Nevertheless, in a step towards greater transparency, RBI recently released disaggregated data for its inflation surveys till September 2017. RBI also released the questionnaire and announced that it will release detailed data for subsequent survey rounds with a one-quarter lag.
The disaggregated data provides further insight on inflation expectations and reveals that variation in households’ expectations has narrowed. The range of expectations between the 25th percentile and the 75th percentile has contracted, mainly owing to a lesser number of households now holding very high inflation expectations. The 25th to 75th percentile denotes how the middle half of households perceives inflation.
In 2014, around a third of households expected one-year ahead inflation to be above 25% YoY. However, only 7.4% of households held such a view in September 2017.
It is difficult to pinpoint the reasons behind the fall in inflation expectations since 2014. Of course, the most plausible explanation remains RBI’s anti-inflation stance even before inflation-targeting was formally adopted in February 2015. Perhaps, the narrowing gap between actual inflation and median expectation shows RBI’s improving credibility on the inflation-targeting front.
However, the fall in inflation expectations could also be attributed to the fall in actual inflation amid declining global crude oil prices in 2014. Moreover, reduction in fiscal deficit and lessening of “policy uncertainty” might also have played a role. “Economic policy uncertainty” apparently has considerable effect on households’ inflation expectations, according to a research paper by Taniya Ghosh of Indira Gandhi Institute of Development Research, Sohini Sahu of IIT-Kanpur and Siddhartha Chattopadhyay of IIT-Kharagpur. Policy uncertainty is denoted by the index developed by Scott R. Baker of Kellogg School of Management and co-authors, using newspaper commentary on economic policy.
Whatever might be the causes, the fall in inflation expectations bodes well for RBI. However, there remains notable variation across population groups, which needs to be explored further. Financial sector employees tend to have the lowest inflation expectations among various groups, judging by their qualitative and quantitative responses. On the other hand, the expectations of retired persons and daily workers appear to be on the higher side.
The fact that retired persons see a higher inflation rate, rightly or wrongly, is worrisome. They are particularly vulnerable to inflation as they mostly spend out of their savings or some fixed return on savings. Inflation reduces the real value of savings and income stream. Even if we assume that higher inflation leads to economic growth and job creation, retired persons seldom get to enjoy these spillover gains from inflation.
Perhaps RBI would do well to release data on survey respondents’ income levels when it next releases disaggregated data on households’ inflation expectations.