Number Theory: Core inflation, food basket, and the new targeting debate
Energy prices are an important driver of inflation in any modern economy, especially one such as India which is heavily import-dependent for its energy needs.
India’s benchmark inflation number, as measured by the Consumer Price Index (CPI), fell to a five year low of 3.5% in July because of a favourable base effect. It was the first time in five years that the number was below RBI’s target of 4%. The respite from inflation, if one goes by RBI’s own projections, is only temporary and the headline number is expected to stay above RBI’s target of 4% in the current fiscal. Since the current inflation problem is a result of high food inflation -- it has a share of 39% in the CPI basket – there have been arguments, including from finance ministry’s Economic Survey, that the inflation-targeting framework should consider tracking core inflation – the non-food non-fuel part of the CPI basket – rather than the overall index. The argument is persuasive. Interest rates, after all, cannot correct supply-side shocks in food markets, which are the biggest reason for food inflation. High interest rates hurt overall growth. But when seen from a larger perspective, it might not be the best thing to do. Here are three charts which explain this argument in detail.
