Keep Targeting on Target

The Economic Times     8th October 2020     Save    
QEP Pocket Notes

Context: Reserve Bank of India’s response to COVID, indicates that Monetary Policy’s inflation targeting has worked well despite several criticisms raised against it.

Critique of Monetary Policy’s Inflation targeting:

  • Impact of Global Influence: Indian inflation is considered to be largely influenced by global developments; therefore steering inflation is a challenging task.
  • Focus on Food Inflation: Monetary Policy Committee is criticised for paying too much attention to food items which are considered to be highly volatile due to dependency on weather.

Arguments in favour of Inflation targeting:

  • Balancing inflation and output: RBI responds to both changes in inflation and changes in the output gap and balances both the considerations. 
    • Thus, it is best characterised as a ‘flexible inflation targeter’, not an ‘inflation nutter’.
  • Enhanced forecasting:  Inflation expectations are better anchored than before on the adoption of inflation targeting.
    • Improved anti-inflation credibility: Increase in actual inflation does less now to create expectations of continuing inflation.
  • Improved expectations owing to inflation targeting provided RBI with the room to act: RBI was able to cut interest rates in response to the crisis, despite the fact that inflation was high.
    • International experience also shows that inflation targeting regimes in emerging markets had greater scope for interest rate cuts as compared to their counterparts.

Steps to Improve Monetary Policy’s Inflation targeting:

  • Attention to food inflation: Food price inflation in India impacts core inflation, as the producers mark up the prices of other products in response.
    • Prescribing standard advanced-country practice (where fuel and fuel don’t impact core inflation that much) for a country like India would be monetary malpractice. 
  • Improving household’s forecasting: Inflation targeting hasn’t helped ordinary households much; thus, the RBI needs to take further steps to communicate effectively with the general public. 
QEP Pocket Notes