Phillips Curve in Indian Context
The Phillips Curve posits an inverse relationship between inflation and unemployment (or the output gap), but in India the relationship is complicated by the dominance of food inflation — driven by supply-side shocks — and a large informal sector, making the MPC's task of managing inflation-growth trade-offs particularly challenging.
The original Phillips Curve, formulated by economist A.W. Phillips in 1958, identified an empirical inverse relationship between wage inflation and unemployment in the UK. Modern versions use the output gap (actual GDP minus potential GDP) as the activity variable, hypothesising that above-potential growth creates inflationary pressure, while below-potential output (slack) reduces inflation.
In India, the CPI inflation basket is dominated by food and beverages (approximately 46% weight), which are primarily supply-side determined — driven by monsoon outcomes, agricultural productivity, fuel costs for transport, and global commodity prices. This structural feature means that India frequently experiences high food inflation alongside a negative output gap, violating the standard Phillips Curve relationship. The MPC faced exactly this challenge in FY22-24: CPI remained elevated (averaging 6%+ for extended periods) driven by tomato, onion, and vegetable prices, even as the economy was growing below potential.
RBI's own research suggests the output gap-core inflation relationship in India is weak and unstable. A 2022 paper by RBI staff found the New Keynesian Phillips Curve fit for India was considerably less robust than for developed economies, partly because wage data is incomplete (PLFS surveys cover only part of the labour market), the informal sector is very large, and food inflation is exogenous.
The practical consequence for the MPC is that tightening monetary policy to cool food inflation is largely ineffective — raising repo rates does not make rainfall better or reduce supply disruptions. Yet the MPC is mandated to keep headline CPI within 2-6%, which includes food. The MPC has used the distinction between durable (persistent) and transitory inflation to calibrate its response — tightening when core inflation (ex-food and fuel) is elevated, but tolerating transitory food spikes.
The labour market dimension is further complicated by the fact that India lacks a comprehensive, high-frequency unemployment rate time series. CMIE's Consumer Pyramids Household Survey provides monthly data, but methodological differences from ILO standards and the informal sector's dominance make it a noisy indicator of actual economic slack.