Inflation, Core Inflation, Food Inflation... You hear all these numbers
But why do they matter?
How do RBI and the Fed look at them?
How do these impact interest rate policy? And do interest rates matter to markets?
A quick look:
- The Fed and many other Central banks often talk of core inflation which is inflation net of food & fuel costs.
The logic being that this part cannot be targeted via interest rate actions of Central banks. Food inflation is often due to supply issues and interest rates which try to target demand in the economy may not be able to change food demand or prices.
- On the other hand, the RBI usually looks at total inflation. This time the Economic Survey said that RBI should start looking at inflation net of food.
- However this does not make so much sense for India because India is a much poorer country than the West.
Our per capita income is 3% that of the US (Yup, that's right) Even in PPP (purchasing power parity) terms, the US per capita income is about 10 times that for India.
- Hence food is a much larger component of the consumption basket for Indian - about 40-50% on the average, depending on which particular segment you take.
- Also, food inflation has been particularly high in the last few years.
As Sayantan Bera wrote in Mint quoting a RBI paper, food inflation averaged 6.3% during June 2020 to June 2024 compared to just 2.9% between 2016 and 2020.
- RBI cannot ignore food inflation in policy making because
1. Since food is such a big part of the household budget, if food inflation is high it reduces money available for other purchases.
If tuar daal prices go up, Indian households may cut back on toothpaste or soap - that's how precarious the situation is for them.
2. Food inflation results inflation elsewhere too - everything from transport prices to electrician charges go up and that is how food inflation leaks into the prices of other products.
3. One of the main areas targeted by central banks through interest rates is inflation expectations in the economy because that, in turn, drives actual inflation with a lag. If you expect inflation to be high you will ask for a higher salary raise, for example.
Since the individual does not make any distinction between inflation that comes via food or petrol prices versus inflation elsewhere, if food inflation remains persistently high it ups the inflation expectations in the country.
In my opinion, in a country like India, RBI has to take total inflation into account and not just inflation, net of food and fuel.
Why does the RBI's thinking matter to you?
Because interest rates have an impact on markets too. How? Had done a whole video on how that linkage works. Here's the link:
From the desk of
Devina Mehra
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