ABSTRACT
This study constructs a model-based core inflation for India using Divisia monetary aggregates instead of traditional money measures with the methodology proposed by Bagliano and Morana (2003) and evaluates its forecasting abilities. The core inflation derived from Divisia monetary aggregates is found to be a better leading indicator of measured inflation than the core inflation derived from traditional money measures. These results argue for a case in favour of using monetary aggregates in the construction of core inflation for policy purposes.
Disclosure statement
No potential conflict of interest was reported by the authors.
Notes
1 See, for example, Bryan and Cecchetti (Citation1993), Quah and Vahey (Citation1995), and Bagliano and Morana (Citation2003).
2 Barnett’s critique states that incoherency and instability in econometric systems may arise due to the use of theoretically inconsistent data (Chrystal and MacDonald Citation1994).
3 For a detailed review on monetary aggregates, see Barnett and Chauvet (Citation2011).
4 The benchmark rate of interest (Rt) is chosen as the maximum rate among a set of market rates such as prime lending rate (BPLR) of SBI, yield on long-term government securities (rgs) and the rate of return on components M3 and is given as: .
5 All the core inflation measures are unbiased in the long run as for
(results not reported in the table).
6 The ADF and PP unit root test indicated that all the time series as I(1) process.
7 The VECM is estimated with two lags as indicated by SBC and HQ information criteria for all the models.
8 Results are available on request.
9 We used a rolling window of 72 months in length.