When we focus on inflation on a year-on-year basis, as we tend to do in India, we miss out on the inflationary process described above. Also, as the clamour and the drumbeats increase, policy could, erroneously, respond to price rise that has actually already been brought under control. Or, it could mean that when prices start moving on an upward path month after month, the year-on-year rate will miss the trend.

The way this problem has been addressed in developed countries is to focus on monthly changes. There is, however, one problem with monthly changes. If there is seasonality in the data, it might suggest there is a rise in prices and we might start taking policy action, but that would be a mistake. In other words, when the mango season ends — as is happening now — and the price of mangoes goes up, even doubles, or triples, there is no need to panic. This is merely seasonal. The price of mangoes will come down when the next mango season comes. So while economists like to focus on monthly inflation, they do so after seasonally adjusting the data. All this seems fairly obvious. Some of the simplest techniques available to do this are nearly a hundred years old. The latest techniques are ubiquitous today, software packages to apply them are available for free download on the internet and any economist with a training in statistics and with a view to understanding the process of inflation in India can do so with fairly little effort. Even though economists disagree on the details of various techniques, various methods give similar results and serve the broad purpose.

... contd.