No Country For Inflation Targeting

The Indian Express     20th March 2021     Save    
QEP Pocket Notes

Context: Three decades after the start of the inflation targeting (IT) policy in New Zealand (1990), a question worth asking is whether it has succeeded in its primary objective of reducing inflation.

 

Major tools to control Inflation:

  • Monetary Tools - Inflation Targeting through Monetary Policy Committee in India.
  • Fiscal Tools – through the enactment of Fiscal Responsibility and Budget Management Act (FRBM)

Inflation Targeting in India:

  • Introduction: Based on the Urjit Patel Report (2014), inflation targeting was instituted in 2016.
  • Features: Monetary Policy Committee in October 2016, formally announced the following-
    • A real repo rate of 1.25% as the neutral real policy rate (consistent with growth at potential or growth equal to that obtained at full employment).
      • Since the GDP growth was 7.9% and inflation was 5%, the repo rate was kept at 6.25%.
    • The primary goal of IT was to contain inflation at around 4%, within the allowable range of 2 to 6%.

Issues with Inflation Targeting in India:

  • Decline in the growth due to high repo rates: from 8% (pre- IT) to 5% (post IT)
    • High real policy rates are due to the mistaken belief that high policy rates affect the price of food or oil.
    • It affects the cost of domestic capital in this ultra-competitive world and thus leads to low GDP growth.
  • Inflation is truly global: the decrease in inflation post IT cannot be attributed as a success of IT policy.
    • One country, through its IT policy, cannot influence the price of any item or the general price level.
    • E.g. Price of oil set by an oligopoly increased 13 times over a period of 9 years (from $9.8 a barrel in 1998 to $ 133/barrel in 2008) but had no impact on Advanced Economies (AEs) inflation.
  • Historical low inflation questioning its significance: Golden period of Inflation in India was without FRBM or IT policy - the lowest inflation in Indian history occurred during 1999-2005 (3.9%).
  • Many countries without inflation targeting had lower inflation.

Conclusion: Considering the low growth associated with IT policy, we can conclude that India is not in a position for continuing with Inflation targeting.

QEP Pocket Notes