Does RBI need to revise its models?

The low inflation print in recent months has raised some important methodological questions. RBI relies heavily on the internal models that it has developed for its inflation forecast and hence for making interest rate decisions. The table below shows some of the recent long-range forecast envelops and the actual inflation prints at the end of the forecast periods.

Table 1: Sample long-range RBI forecasts for inflation

Forecast Date Forecast Period 90%tile Upper Bound 90%tile Lower Bound Actual CPI
Oct-16 Q1FY18 8.8 1.8 1.5
Sep-16 Q4FY17 8.4 3.2 2.7
Feb-16 Q3FY17 8.4 2.2 5.3
Sep-15 Q4FY16 8.4 3.2 6.3
Mar-15 Q3FY16 8.6 2.8 4.6

Source: Decimal Point Analytics

The table shows that the long-range forecasts made till Feb 2016 were able to predict the inflation within the margin of error. However, since Sept 2016, the forecasts published by RBI are too high as compared to the actual reads. The actual readings are coming outside the 90 percentile range, and way below the median.

It would be interesting to analyze this phenomenon in detail to study if this is a transient effect or as suggested by us previously a paradigm shift in the efficiency of Indian economy. The result of this analysis will have profound effect on the conduct of monetary policy and on the growth prospects of India.

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