RBI: Inflation Forecast Model Amended

The Reserve Bank of India recently revised its Inflation Forecast Model. The new model will capture how fiscal and monetary policy interact with real economy elements in a better way.

About the New Inflation Forecast Model

The new model is broken into three blocks. The first block decomposes the primary deficit of the Government into structural and cyclical components. It is also called fiscal block. A structural increase in deficit of the Government will create a positive output gap. This will in turn make borrowings costlier and will eventually depreciate the currency. This means country will face higher inflation. On the other hand, the cyclical shock is negligible.

The second block includes the complex system of pricing in India. It includes items such as diesel and petrol that are priced on the basis of international oil prices, local taxes and exchange rates. This block is also called the fuel block.

The third block is the Balance of Payment block. This block recognizes the costs that are associated with spurts in volatility in exchange rate.

How is inflation measured in India?

In India, inflation is measured using two main indices namely Wholesale Price Index (WPI) and Consumer Price Index (CPI). The Consumer Price Index measures the weighted average of prices of basket of consumer goods and services such as food, transportation and medical care. It is measured by calculating the average of price changes of each item in the predetermined basket of goods. On the other hand, the Whole Price Index is measured based on prices at wholesale level.

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