An Analytical Study on Inflationary Expectations with Reference to Evidences from the World

Abstract

Amidst the dynamic global financial environment, developing countries like India have a host of opportunities available. Alongside comes macroeconomic disturbances channelized both through internal and external factors. Inflation in such scenario becomes a very important variable. India, especially after 2008 has observed the crucial role played by the financial markets in building macroeconomic strength of the country. Hence, it becomes imperative for the world economy to focus on inflationary pressures in the country.

The relevance of inflationary expectations has been understood long back in 1960s when Milton Friedman, in December 1967, in the eighteenth Annual meeting of American Economic Association introduced the significance of the subject officially for the first time. He proposed that economics function efficiently if all its agents, viz., producers, consumers, employers and employees anchor their behaviour confidently in line with swift anticipated movement of prices in future. In this backdrop he raised three crucial questions, “(i) How to measure inflationary expectations?, (ii) How expectations affect inflation?, (iii) What affects inflation expectations and how well expectations are anchored?”.3 Policymakers across the world understood the important bearing these expectations have on the actual level of prices to have a hold on the erratic monetary environment and started conducting research in full swing mode to evaluate how people anchor their expectations about prices in the future. This was a gigantic move by economies to understand how these changes over time have a favourable and healthy monetary environment.

This urgency has been understood by numerous central banks across the globe while targeting inflation. RBI, following the suit also started considering inflationary expectations 2008 onwards. It recognized the importance of its determinants and has taken a few steps to evaluate the premises on which people in India anticipate prices. RBI conducts the Household Inflation Expectations survey to provide directional information on near-term inflationary pressures. These expectations are formed by individuals based on their consumption baskets across 18 cities of the country. (RBI report on Quarterly Survey on Inflationary Expectations of Households)

Researchers worldwide have done extensive study to evaluate varied factors affecting how inflation expectations are formed that leaves a big room for Indian researchers to dig deep the main determinants of anchoring inflation in India. Withstanding the importance of inflation as a macroeconomic variable, the country has now adopted flexi-inflation targeting policies that helps anchor expectations, with the dispersion of inflationary expectations declining considerably, particularly during periods of high uncertainty (RBI, monthly reports). Apart from the inflation target, the stance of fiscal policy is instrumental in shaping expectations (William E. Gibson, 1972).