In mainstream macroeconomics today inflation is related to the ‘output gap’, defined as the deviation of output from its ‘natural’ level. This view of inflation has been adopted by the leading central banks, including India’s, underpinning the move to ‘inflation targeting’ as the sole objective of monetary policy. We present an alternative model of inflation based on features that would be considered typical of the Indian economy and a specific understanding of what drives the inflationary process here. We then test both the models across data from India over different periods and at differing frequencies. The exercise is conclusive, and bears significance for what will constitute an appropriate antiinflationary policy.
Pulapre Balakrishnan,
