The Error in the CPI, Which Precludes It Use in Inflation Targeting

I  examine the trends in the CPI and the core part of the CPI to bring out a grievous error in the core CPI. The core in certain years shows a jump of as much as 7% in certain quarters due to the error in the way the rent prices are computed. During the periods following the Pay Commission implementation, the “ rent” prices rise in the CPI, because the rents for the entire population are imputed from the “House Rent Allowance” accorded to government employees. “Rents” in the CPI have jumped up by as much as 35% in certain quarters, hugely overestimating the true inflation. This vitiates any use of the core CPI for monetary policy including inflation targeting. This will-o’-wisp that the RBI chased, had no doubt constrained growth in India.

The RBI in using the Core CPI measure (red) which is affected by the erroneous “House Rent” component, tightened heavily c. 2011-12 and kept the rates high, when the fiscal stimulus had already been withdrawn;  to bring out the longest period of slow growth since the Great Liberalisation and reforms of 1991-92/92-93.

For the full paper see:

Morris, Sebastian, The Error in the CPI, Which Precludes It Use in Inflation Targeting (May 01, 2021). GIM WORKING PAPER SERIES; WPS No. 01/EC/May 2021, Available at SSRN: https://ssrn.com/abstract=3877102 or http://dx.doi.org/10.2139/ssrn.3877102 

Click here to download