Context

India’s central bank has revised its inflation-forecasting model to better capture how fiscal and monetary policy interact with real-economy elements just after days the RBI won approval from the government to retain the inflation target in between 2%-6% range for the next five years.

About

The new Model or quarterly Projection Model 2.0

• The Quarterly Projection Model 2.0 is an inflation forecasting model.
• The new framework is a forward-looking, open economy, calibrated, new-Keynesian gap model.
• The previous version was often criticized for over-estimating upside risks to inflation.
• Under the new model the adjustments incorporate fiscal-monetary dynamics, which include
  • India’s unique and often chaotic fuel pricing regime
  • exchange-rate fluctuations and their impact on balance of payments

The new model is differentiated into three blocks:

• First or fiscal block: It decomposes the government’s primary deficit into structural and cyclical components.
• Second, or fuel block: It takes into account India’s complex system of pricing.
• Third or balance of payments block: It recognizes the costs associated with spurts in volatility in the exchange rate.

Inflation  It refers to the rise in the prices of most goods and services of daily or common use, such as food, clothing, housing, recreation, transport, consumer staples, etc.  Inflation measures the average price change in a basket of commodities and services over time.