1. Great expectations!

Great expectations!

One of the reasons given by market economists for the Reserve Bank of India not cutting repo rates has to do with inflationary expectations.

Updated: November 19, 2014 4:50 AM

One of the reasons given by market economists for the Reserve Bank of India not cutting repo rates has to do with inflationary expectations. The traditional argument is that as long as people have high inflationary expectations, the central bank cannot afford to lower its guard since these expectations can very quickly get translated into real inflation. If people have high inflationary expectations, for instance, they will demand higher wages during renegotiations and that will, over a period of time, feed into the CPI/WPI indices. If repo rates are kept high, the logic goes, inflationary expectations will be dampened. Inflationary expectations, in turn, are measured by an RBI survey just before each policy.

The problem, however, as the table below makes clear, the expectations are completely out of sync with reality. The expectations survey projected a 14.5% inflation level for January 2014 while the actual inflation in that month was a much lower 8.8%. This perception gap has worsened, and while the projection for September was an inflation level of 14%, the reality was a 5.5% level. Time to give up on the expectations theme?

graph-expectation

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