Separating shocks from cyclicality in Indian aggregate supply

Abstract

Simultaneity issues as well as incorrect measurement of shocks and of the cyclical variable bias estimated slopes of the Indian aggregate supply curve (AS). Our initial Generalized Method of Moments estimation, based on a filtered output gap variable and including supply shocks, also gives an unrealistic downward sloping AS. But we find measures of asymmetries in price changes outperform traditional measures of supply shocks. Estimation using marginal costs as a proxy for the output gap gives a positive coefficient that reduces in size on including our comprehensive supply shock variable, implying the correct AS has a small positive slope, but is subject to multiple shifts. The semi-structural specification, closer to firms' actual decisions, gives estimates of structural parameters such as degree of price stickiness and extent of forward-looking price adjustment. The results more correctly separate shocks from cyclicality, help to interpret India's growth and inflation experience, and have implications for policy.

Inflation Dynamics and Monetary Policy in India: A New Keynesian Phillips Curve Perspective

“…Goyal and Tripathi (2015) found the support for the New Keynesian aggregate supply curve in India when the output gap is replaced with a marginal cost variable using annual data. Their results suggested that the share of firms setting prices in a forward-looking manner exceeds those with backward-looking firms.…”

“…Equation (7) of the NKPC denotes that a central bank can control inflation due to aggregate demand pressures without cost by committing to keep the output close to its potential level in the future (Goyal & Tripathi, 2015).…”

Correlated Shocks, Hysteresis, and the Sacrifice Ratio: Evidence from India

“…There are estimates of the Phillips curve for India (Paul, 2009, Singh et al, 2011, Kotia, 2013, Goyal and Tripathi, 2015. But the implications of correlated demand and supply shocks are yet to be explored.…”

“…There is evidence of a flat aggregate supply curve with multiple supply shocks for India(Goyal and Tripathi, 2015;Goyal 2011). …”

Phillips Curve Relationship in India: Evidence from State-Level Analysis

“…Patra et al (2014) explore the sources of inflation persistence in India in the NKPC framework and find: (a) supply side shocks in the form of relative price increases, particularly for food, influence aggregate prices lastingly; (b) an increase in inflation persistence in the post-2008 period; and, (c) a high degree of interest rate smoothing could be imparting persistence to the inflation process. Goyal and Tripathi (2015) find that the estimated slope of the Phillips curve is sensitive to the method of estimation and to the measurement of the supply shocks and the output gap variable. Better measurement of the supply shocks and the output gap variables reduces the size of the coefficient on the output gap.…”