Estimation of Unobserved Inflation Expectations in India using State-Space Model

Inflation expectations is an important marker for monetary policy makers. India being a new entrant to the group of countries that pursue inflation targeting as its monetary policy objective, estimating the inflation expectation is of paramount importance. This paper estimates the unobserved inflation expectations in India between 1993:Q1 to 2016:Q1 from the Fisher equation relation using the state space approach (Kalman Filter). We find that our results match well with the inflation forecasts made by the Survey of Professional Forecasters conducted by the Rerserve Bank of India and by the International Monetary Fund for the Indian economy. We apply the estimated series on inflation expectation to show that there is a long-run equilibrium relation between inflation expectations and monetary policy in India during the post liberalization period.