Thursday, 8 April 2021
The central bank said it has revised its inflation-forecasting model to better capture how fiscal and monetary policy interact with real-economy elements.
The adjustments incorporate fiscal-monetary dynamics, India’s unique and often chaotic fuel pricing regime, and exchange-rate fluctuations and their impact on balance of payments, the Reserve Bank of India said in its latest bi-annual monetary policy report published Wednesday.
Dubbed as the Quarterly Projection Model 2.0, the RBI’s economists describe the framework as a forward-looking, open economy, calibrated, new-Keynesian gap model. The previous version had often been criticised for over-estimating upside risks to inflation.
The amendments come just days after the RBI won approval from the government to retain its 2-6 per cent inflation target range for the next five years. It didn’t offer a comparison between inflation rates predicted under the previous model and the new one, but said its tools helped it keep inflation anchored around the 4 per cent midpoint on average in the past five years.
The RBI said the new model is broken into three blocks. The first, or fiscal block, decomposes the government’s primary deficit into structural and cyclical components. A shock to the former impacts inflation through aggregate demand and country risk premia; for instance, a structural increase in the deficit would create a positive output gap and the higher debt makes borrowings costlier and depreciates the currency, leading to higher inflation. A cyclical shock is negligible.