Inflation dynamics in India: A hybrid New Keynesian Phillips Curve approach

This paper examines the short run inflation dynamics in India over the period 1996-97 to 2009-10 using quarterly data. I estimate an open-economy version of the hybrid New Keynesian Phillips curve (NKPC) and find that the hybrid NKPC provides a robust explanation of the dynamics of both wholesale price index (all commodities) inflation and manufacturing sector inflation over the sample period after considering supply shocks. Specifically, the price setting agents in the economy are guided by both backward-looking and forward-looking behaviours. The agricultural and the industrial output gaps (used separately to account for the role of sectoral characteristics), fuel inflation, exchange rate and foreign inflation are significant determinants of the wholesale price index inflation. All the variables except exchange rate are found to be significant in determining the manufacturing sector inflation in India.