It Might be Time to Rethink our Inflation-Targeting Framework

Context: The current inflation-targeting framework seems neither suited to India’s developmental needs nor as effective as claimed

Issues with the current Inflation-Targeting (IT) Framework

• Disagreement on what constitutes high inflation: Since, high inflation acts as a tax on the poor.

• There was no basis for the 2% rate that is supposedly targeted by central banks in developed countries.
• Empirical evidence shows that for India as a developing nation, a 4% inflation rate is too low a target.
• The threshold level at which inflation turns adverse for growth is not a settled issue, nor are the causes of inflation and the agency of the central bank in achieving price stability.
• If the central banks were instrumental in bringing down the inflation, they abysmally failed it pushing it upward.

• Inflation as an imperfect gauge of economic expansions: has become evident in the pre-crisis era – as reported by Bank of International Settlements (BIS) Annual Report 2015-16.

• This is expected in a highly globalized world in which competitive forces and technology have eroded the pricing power of both producers and labour.
• BIS, thus, lays out its theory of inflation which says that wages matter a lot more than central bank mandates do.

• Ignoring the food prices as a part of Inflation Generating Processes (IGP):  For developing countries like India, food prices are an important part of the IGP.

• However, the Monetary Policy Committee (MPC) relied on its own inflation forecasts, keeping a tight monetary policy.
• In the process, it ignored financial stability and the growth implications of the collapse of IL&FS

Conclusion: In targeting inflation, India has compromised financial stability and economic growth. There is a need to re-examine the appropriateness of the IT framework for its development needs