RBI researchers create index to forecast inflation

Mumbai: The Reserve Bank of India's researchers have constructed a 'demand-supply mismatch index' that could possibly forecast inflation better than many conventional measures such as surveys and output gap assessments.

"The demand-supply mismatch index is found to be positively correlated with headline inflation," Saurabh Sharma and Ipsita Padhi of the Department of Economic and Policy Research wrote in a report. "Results suggest that the estimated index exhibits a causal relationship with the headline inflation, and has superior inflation predictive power compared to other conventionally used measures of excess demand."

This is probably because supply and demand factors affect prices in different ways where the demand shocks get addressed quickly while supply-side issues could linger for a longer time.


An analysis of impulse response of output to average demand and supply shocks suggests that most of the impact of demand shock fades away within five quarters while the impact of supply shock persists for over 15 quarters, the researchers said in RBI's Working Paper Series.

The series is more academic than being associated with its decision making. It is not clear how much of this the RBI would use in its inflation forecasting in the future.