Monetary policy is crucial to manage household inflation expectations, shows RBI study

The RBI released a study paper in its July bulletin to understand the Indian household inflation expectations. This study uses unit level data on 1-year ahead median inflation expectations from the Reserve Bank?s Inflation Expectations Survey of Households (IESH), to understand their dynamics post pandemic, key determinants and effectiveness of monetary policy in anchoring these expectations, particularly under the flexible inflation targeting (FIT) regime.

Household inflation expectations are particularly important because households represent the largest and most diverse economic group, directly driving consumption. Unlike professional forecasters, households? expectations are often shaped by personal experiences and are susceptible to fluctuations.

Indian household inflation expectations, revealing that they remain elevated compared to those of professionals, even during periods of price stability. Demographic factors such as gender, age, and professional background play significant roles.

Notably, men, older individuals (45 and above), self-employed and daily workers, who often operate on variable incomes, exhibit higher inflation expectations.

In contrast, younger and salaried individuals show less disagreement and are more attuned to realized inflation dynamics, likely reflecting their exposure to financial and social network.

Transition to the FIT regime, along with timely fiscal interventions such as export bans and lower import duties, and moderating inflation levels have contributed to decline in both the levels of expectations and disagreement across responses.

However, supply shocks and global inflation shocks induced by the pandemic and geopolitical tensions have elevated the inflation expectations, particularly across headline, food and housing categories.

High food inflation during periods of high inflation may keep the expectations elevated, even as headline matters more for inflation expectations. Nonetheless, most recently, as inflation has been showing signs of easing, expectations of households have also come down.

Given the evidence of non-rationality and heterogeneity across different groups of households ? each reflecting their systematic biases ? the role of monetary policy becomes critical in managing inflation expectations.

This, in turn, underscores the challenges of effective policy communication, making it essential to understand how these expectations are shaped and managed.

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