Searching Threshold Inflation for India



results as number of variables were dropped from the main equation due to unavailability
of the data. Thus study relies mainly on the results of estimated equation with annual series.

Considering the contrary nature of results with regard to Bhanumurthy and Alex (2008),
Kannan and Joshi (1998), we further perform Hansen (1997) test to check the consistency
of the estimated model. Estimation result using Hansen (1997) procedure though revealed
presence of threshold but at a very higher level of inflation (see figure 5). Thus, on the
basis of combined results of spline regression and that of Hansen test, it could be said that
there is no threshold inflation for India.

4. Conclusion

Using annual data, present study examines the presence of threshold level for India. Result
of the study shows the presence of the threshold for India at 6 percent level of inflation.
Despite the fact that the estimated threshold inflation is out of the comfort zone of the RBI,
but still it is below the present level of inflation. Existence of threshold around 6 percent
inflation rates confirms the existing nervousness in both monetary policy and fiscal policy.
In addition to this, negative link between inflation volatility and output growth recalls for
use of policy instrument so that inflation can be put on a stable path.

Though the estimation results primarily favors presence of threshold level of inflation for
India but in Sarel (1996) sense it lacked to provide evidence on threshold inflation. In this
light, the results, certainly advocates that lowering down the inflation in Indian context will
results in higher output growth. High and persistent inflation not only puts central bank of
the country in trouble, as maintaining low and stable price level is one of the central aim of
the central banks; but it also have welfare cost of foregone economic output. The reasons,
that could be adhered to why inflation inhibit growth in particular to Indian context is
probably the effect of inflation on rate of investment. Higher rate of investment is required
to meet the growing demand of a developing economy; inflation will hurt output growth
through its effect on lowering the rate of investment. Second, a huge population in India
works in unorganized sector and their wage is not indexed to inflation, which means that
the real disposable income effect will reduce the total consumption and further will have its
effect on growth as Indian economy is largely driven by domestic demand. With
increasingly openness of the economy and ever increasing requirements of it in the sense of
investment and with high capital inflows it has become very much important for the RBI to
use policy for inflation. During the time of high capital inflow RBI need to sterilize,
actively, the domestic monetary base to maintain low and stable inflation.



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