The Reserve Bank of India on December 16, 2021 has published a Working Paper titled “An Alternative Perspective on Demand and Supply to Forecast Inflation”. The paper develops a new method to construct a measure of demand-supply imbalance in the economy using a Bayesian Dynamic Factor Model. The estimated index of demand-supply mismatch is found to have a causal relationship with headline inflation. It is also found to be a competing predictor of headline inflation, as compared to other conventional measures of slack such as the output gap and level of capacity utilisation.
