Context: A critical analysis of the claims regarding the success of flexible inflation targeting in India.
Evolution of Inflation Control:
Globally, in?ation control became de rigueur after the high inflation that followed the oil shock in the early 1970s. (Brought in by Milton Freidman who suggested monetary-supply targeting)
In India, policymakers had engaged with in?ation since the 1950s, when plans to industrialise met the challenge of in?ation.
In 2016, an agreement was signed between the Central Government and the Reserve Bank of India to keep the inflation rate in the prescribed band of 2-6%.
Significance of Inflation Targeting:
Kept the inflation in check: the inflation rate had remained within the prescribed band of 2% to 6% since 2016 when in?ation targeting was introduced
Successful Inflationary Prediction: the RBI has succeeded in anchoring in?ationary expectations.
Concerns over the efficacy of inflation targeting
Natural rate of growth is unobservable: Since this model revolves around the proposition that in?ation re?ects “overheating”, or economic activity at a level greater than the “natural” level of output.
Central banks have kept interest rates too low, at a level lower than the “natural” rate of interest.
Not statistically validated with Indian data: For e.g., While the inflation was already between the 2-6% band before 2016, it has steadily declined, halving by 2015-16.
This by itself suggests that there is a mechanism driving inflation.
Conflicting patterns with other variables:
Economic growth: Began to decline since 2010-11, and low inflation and falling interest rates couldn’t help in reviving growth prospectus.
Investments: Private investment rate continuously declined despite the low inflation period, which is considered conducive for investments.
Exports and employment: Fared poorly.
NPAs: grown since 2016, and the cases of IL&FS, PMC Bank, PNB and YES Bank suggest that poor management and malfeasance can overpower RBI’s inflation controlling efforts.
Conclusion
Inflation control will always be relevant, but there is no conclusive evidence that the policy has worked in India.
Presumed benefits of low inflation are yet to surface.
Assuming that the decline in in?ation in India is due to in?ation targeting would stand in the way of acknowledging the source, the vagaries of the price of food.