Inflation has external causes
The most important reason for retail numbers being significantly higher than WPI could possibly be because of the transaction cost of food items that gets embedded in retail price through inflationary expectations. Transaction costs include transportation, intermediation, electricity for cold storages, mandi commission charges, etc. FICCI research shows that if the farm gate price for onion is R100, then the retail price could be R121.4 plus the mark-up at the retail level! Clearly, the increased retail prices over a long period of time may be attributed to a large extent on supply bottlenecks, on which the central bank may not have any control.
Also, historical trends suggest that the last time retail inflation numbers were below 5%, was in January 2006, exactly six years ago. If we assume that RBI still looks at a 5% acceptable inflation rate even for food inflation, then purely going by retail inflation numbers will not justify any rate cut any time in the near future.
Interestingly, we also used a set of statistical tools to understand the impact of an interest rate increase on output growth. We estimated Impulse Response Functions (IRFs), which are simply a set of coefficients that summarise
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