LAUSR

Abstract We analyse the factors influencing Indian households’ inflation expectations and draw out implications for inflation targeting. The literature finds news on inflation affecting expectations. Using quarterly data from India over 2008-2019, we find: (i) in estimated epidemiological models of learning in expectation formation, the response coefficient on inflation news in the shape of central bank forecasts exceeds coefficients estimated for advanced economies, implying official views having a relatively greater weight on expectations; (ii) error variance decompositions of expectations to shocks in variables including commodity and core inflations, demand and policy variables in a series of SVARs, also show policy communications affecting expectations in the short-term. Food inflation has a significant short-run effect on expectations, but demand determined core inflation dominates over the long-run; (iii) impulse responses show a rise in the policy rate raising expectations. Results imply communications are a more effective tool in influencing expectations compared to policy rates.