Inflation expectations: What are these and do they really play a role in India’s economy?

What is important is future inflation, which is why expectations of price levels matter.

Rising crude oil prices, for example, portend higher general inflation ahead. A possible El Niño weather phenomenon this year can influence inflation expectations for the second half of this year as there could be deficient monsoon rainfall, which could cause food prices to rise.

These expectations tend to feed decisions taken by consumers and producers, turning rising prices into a kind of self-fulfilling prophecy and affecting the economy. But does it really work this way?

In India, an anomaly emerges when the inflation rate based on the consumer price index (CPI) is juxtaposed with the inflationary expectations and perceptions of households captured by the Reserve Bank of India (RBI) in surveys conducted on a bi-monthly basis. For 2025-26, for example, there were six surveys carried out, with responses for inflation up to March 2026.

Besides perceptions on prevalent inflation, forward expectations are also sought from respondents. Interestingly, household perceptions tend to be significantly higher than actual inflation.

In RBI’s six surveys conducted in 2025-26, the average of the median rate of perceived inflation was 7.2%, while India’s official CPI inflation as an average over those 12 months was 3.3%. From one survey to another, the gap between perceived and actual inflation was as high as 6 percentage points in September and November.

Inflation expectations are surveyed too, with respondents asked for three-month and one-year ahead figures; these also tend to run higher than actual numbers.

Last year was not aberrative. Household perceptions of current and future inflation have long been found to diverge from the CPI data that RBI uses for monetary policy.

One reason can be that households gauge how their budgets have been affected by the general cost of living over time and use this impact to frame their view. Even when officially recorded inflation was in the 5-6% range—i.e, within RBI’s tolerance band—popular perceptions exceeded the real number by about 200-300 basis points.

At the national level, given the vast expanse of product and service markets from where prices are taken for the index, the overall increase in price level tends to be moderate. Household reactions, however, are based on their very own baskets of consumption, with varying weights for the items they consume. This introduces a ‘subjective bias’ in how people experience inflation.

Also, products and services for which prices have not changed (say, rent, for example) often get overlooked by people when they form perceptions of inflation. The human mind tends to foreground the prices that rose or fell noticeably; these dominate people’s views, resulting in an ‘impact bias.’ Since unbiased estimates are not easy to make effortlessly, this may be a natural tendency.

Likewise, products that have not been purchased in the immediate past may not feature in household perceptions either, while recently bought ones would; so a ‘recency bias’ could also be at work.

The base level on which households and price indices measure change also tends to differ. People typically compare current prices with the near-past; they are rarely able to recollect prices from a year earlier to estimate the annual difference.

CPI-based inflation, however, offers a year-on-year comparison as an annual figure every month. Hence, a spike in onion prices of, say, ₹10 per kg in November from ₹20 per kg in October may lead to an exaggerated view of how their cost of living has gone up, even though the price difference from the previous November may be very little; this can happen because of seasonal cycles of supply in relation to demand.

Further, an abnormal increase in the price of a single item, such as pulses or vegetables, can sometimes crowd out other items in popular perception. This is a ‘shock bias.’

What constitutes inflation varies depending on how one views it.

Producers, both in manufacturing and services, often display similar behaviour. Their view of inflation is likely to be influenced by how their own costs and final-product prices move. If raw material costs or transport services become more expensive, inflationary expectations could rise within the organization.

As varying sectors see varied price movements, responses would differ. Food processing companies might see farm-produce inflation as a cue for price hikes, for example, while rising headline inflation could make consumer-facing businesses worry about demand getting affected by a drop in household purchasing power.

In the West, wage-push inflation sometimes tracks popular cost-of-living expectations, so public perceptions can drive up price levels, but this phenomenon is hardly ever observed in India.

The question often debated here is which inflation number should be used for monetary policymaking. True, the CPI is theoretically constructed and ticks all the boxes. But it also means RBI policy targets an inflation measure whose perceptions are at variance with what the CPI says.

So, while policy is meant to elicit certain responses from economic agents, these could fail to materialize. If household perceptions and expectations of high inflation come in the way of spending, for instance, then interest rate cuts may not encourage people to take consumer loans or companies to borrow for investment in capacity expansion.

While price-level perceptions do not figure in decisions of RBI’s monetary policy committee, any talk of ‘inflationary expectations’ warrants caution. The question to ask is: Whose expectation is it? An economist, an analyst, a household or a company? Their views differ, which makes this concept fuzzy in practice if not theory.

These are the author’s personal views.

The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The Darker Side of the Sun’.