The authors said that similar to India, inflation expectations are biased and not efficient in other countries too, like the US, England, Japan, New Zealand, South Africa, Czech Republic, Philippines and Russia.
New Delhi, India According to a working paper released by the Reserve Bank of India (RBI) on Tuesday, when household sentiments about future inflation are positive, they change their savings portfolio in relation to bank deposits.
According to the paper titled ‘Taking Cognisance of Households’ Inflation Expectations in India,’ inflation expectations play a critical role in regulating households’ consumption behaviour and, as a result, savings.
The RBI’s Devendra Pratap Singh, Aditya Mishra, and Purnima Shaw wrote the paper. The findings of the paper are those of the authors, not the RBI.
“We find that an increase in households’ inflation expectations has a negative impact on their savings in debt-based instruments, such as bank term deposits, indicating their reduced preference for bank term deposits when they expect rising inflation,” the authors wrote in the paper.
Particularly in a developing economy, it is preferable for households to save in financial instruments such as debt or equity, which can then be invested in production-enhancing activities, according to the paper.
However, given the nascent stage of development of corporate bond markets and low awareness of equity markets, the most accessible financial instrument for most Indian households is bank deposits.
If households expect inflation to rise in the medium term and suspect low returns due to low real interest rates, it may be preferable for them to invest in commodities such as precious metals, jewellery, and so on rather than save in term deposits, according to the report.
According to the authors, inflation expectations are biassed and inefficient in other countries, including the United States, England, Japan, New Zealand, South Africa, the Czech Republic, the Philippines, and Russia.
“This indicates that Indian households’ inflation expectations are similar in nature to those of other developed and emerging economies, except for the relatively higher bias than in other economies, with the exception of Russia,” the paper said.
According to the authors, inflation expectations in India have remained sticky as households continue to believe that a period of relatively low inflation is here to stay.
They noted that in India, households’ quantitative inflation expectations are formed based on their experiences with food and fuel inflation.
Changes in inflation expectations do not necessarily reflect the volatility of any particular food item; rather, various food items influence households’ sentiments at various time points due to their weightage in the households’ consumption baskets, according to the authors.
According to the paper, different factors influence household inflation expectations over different time periods, depending on the price movement of specific items.
“A sudden price shock in any item may have a disproportionate impact on households’ inflation perception and future expectations,” the report said.
Furthermore, there are large differences in the sentiments of respondents across cities, it said, adding that forecasting inflation using household inflation expectations presents several challenges in such a scenario.