Abstract
Abstract Inflation in India has been a major cause for concern in the recent past (2008–2012). This study examines the Indian wholesale price index inflation from 1951 to 2012 using P-star (or P*) models after accounting for the nonlinearities in the data by establishing the presence of a nonlinear long-run equilibrium. The paper establishes the presence of a threshold vector error correction model (TVECM) between prices and their long-run equilibrium with three optimal regimes to explain the short-run and long-run dynamics based on an error correcting transition term. Based on these results, the study classifies the various regimes that Indian inflation goes through based on historical economic events. The P* models (price gap, output gap and velocity gap models) were implemented regime-wise. The price gap models (output gap and income velocity gap determine inflation) were found to be optimal in the first and second regimes and consistent with theory. The velocity gap model (which has monetarist foundations) was found to be optimal in the third regime.
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