Inflated expectations in RBI household survey

Jan 31 2014, 10:32 IST
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RBI policies talk of the need to hike rates to prevent inflationary expectations. RBI policies talk of the need to hike rates to prevent inflationary expectations.
SummaryCentral bank is fighting a perception battle over whether the new CPI reflects the reality.

At a time when the central bank is fighting a perception battle over whether the new Consumer Price Index (CPI) reflects the reality on the ground, it needs to deal with another perception problem, the one brought about by the quarterly household inflation expectations survey. It is not clear what weight central bankers assign to each piece of data — there is even a professional forecasters’ survey that is used — but the household survey’s numbers are decidedly out of whack.

In the December survey, for instance, households expect March 2014 inflation levels to be just under 14% (see table).

RBI graph

In which case, given the RBI’s stated objective of controlling inflation, the central bank needs to dramatically hike repo rates. Yet, the professional forecasters’ survey is looking at a 9.9% level in March (though that is an average for the full year). And the reality is that CPI levels today are at 9.9%.

If the survey’s odd expectations were restricted to just this round, it wouldn’t really matter. But, as the table shows, the expected inflation levels are much higher than the reality on the ground. For December 2011, for instance, the September 2011 expectations survey suggested a 3-month-ahead 12.2% inflation while the actual turned out to be 6.5%.

Given the sample size is a mere 4,900-odd households and there seems little evidence of the sample being representative of the population, perhaps such results are par for the course.

The problem, however, is that while RBI governor Raghuram Rajan has, in the past, said inflationary expectations tend to be adaptive in India — that is, they fall when inflation levels fall, and vice versa — enough RBI policies talk of the need to hike rates to prevent inflationary expectations from getting embedded and getting translated into higher wage and other input contracts. Such surveys only result in central bankers getting a distorted view of reality.

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