Inflation Dynamics in India: Evidence from Hybrid New Keynesian Philips Curve

Abstract

This study fitted the hybrid version of the new Keynesian Phillips curve using India time series data with aim of assessing inflation dynamics under different leaderships of the Reserve Bank Governors and the extent within which prices of imported goods contribute in the domestic inflation in India. Monthly time series data for index of industrial production (IIP), RGDP, NGDP, GDP deflator and consumer price index spinning from 1990M01 to 2015M03 was collected from the Reserve Bank of St. Louis website; the model was estimated using generalized method of moment (GMM). The study found the following: i) there is the existence of long run tradeoff between inflation and output, this finding is consistent in all the models; that is, the benchmark model and scenario I and II respectively. ii) the study found the dominance of forward looking firms in price setting; although, Rajan leadership is characterized with the dominance of backward looking firms. iii) The extent of the impact of imported prices to domestic inflation is insignificant as the exchange rate pass-through is less than 0.12% across all the scenarios. iv) the study found that the de-trended IIP, RGDP and NGDP using HP-filter are not good proxies for output gap as the series in most cases appeared with wrong sign and/or statistically insignificant. Therefore the study concluded that the behavior of HNKPC in India is consistent with the theoretical and empirical regularities of the model.