A Markov Chain Model of Inflation in India

In this paper, we advance a Markov chain model for price movements in India, based on the general as well as a selected set of sectional wholesale price indices and on the 3 consumer price indices for 240 months from April, 1981 to March, 2001. The estimation period has been divided into two, viz., pre-liberalisation and post-liberalisation, of 10 years each. We consider 3 general states of monthly price changes - positive (tentatively suggesting inflation), negative (deflation), and zero (stable prices), and estimate the state transition probabilities and the steady state probabilities along with the return periods of these 3 states of price level changes. It is found that in general the state of inflation persists with a high probability and much shorter return period in India. This indicates that price rises have been cumulative and hence inflationary in effect.