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Issues in Measurement of Inflation Targeting
The current practice of measuring the inflation rate from fixed base weight index is outdated and likely to overstate inflation substantially compared to the chain weighted index used in developed countries. Similarly, the treatment of house rent allowance revisions to estimate the housing Consumer Price Index also significantly overstates the headline inflation. Economy-wide inflationary expectations also need proper measurement. Inflation-targeting framework without proper measurement of inflation rate can involve very high real costs and make the policy counterproductive.
The Reserve Bank of India (RBI) Act, 1934 as amended by the Finance Act, 2016 provides a statutory and institutionalised framework for inflation targeting with a tolerance band. It also spells out (in para 221, Chapter XII, Part I) the meaning of “inflation” as “the year wise change in monthly Consumer Price Index expressed in terms of percentage.” It also clarifies that what is implied here is the “Consumer Price Index Combined published by the Government of India from time to time.” The present article discusses some issues in measurement of inflation in India, particularly in the context of inflation-targeting framework. The article begins with some methodological issues in the first section. The likely impact of revisions in the house rent allowance (HRA) for a large number of employees in the formal sector of the economy on the measured headline inflation rate is considered in the second section. The third and final section discusses issues about measuring the inflationary expectations.
Methodological Issues
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