Taming Inflation by Anchoring Inflation Expectations

Book excerpt: Expectations of firms and households about the future trajectory of inflation tend to influence their current investment and consumption/saving decisions, and the price and wage-setting behaviour. By firmly anchoring inflation expectations, monetary policy can prevent a wage-price spiral and moderate the second-round effects of supply shocks, thereby avoiding an inferior macroeconomic outcome of lower growth and higher inflation. Using bias-adjusted survey data on household inflation expectations and estimated inflation expectations anchoring index for India this paper shows that the anchoring performance has improved notably following the adoption of the flexible inflation targeting monetary policy framework in India; the risk of wage-price spiral moderates with firmer anchoring of inflation expectations; and that bias adjusted household expectations hover in close alignment with the headline inflation, besides exhibiting superior inflation forecasting properties.