BackWho will set the inflation target?
Going by the Urjit Patel committee recommendations, if RBI sets the inflation target, it will be interesting to see how the government reacts
Premium
The key takeaway from the 130-page report of the Urjit Patel committee on changes in the Reserve Bank of India’s (RBI) monetary policy framework, put up on the central bank’s website on Tuesday, is inflation targeting. It does not talk about the so-called core inflation or non-food, non-oil, manufacturing inflation and wholesale inflation. The anchor will be the headline consumer price or retail inflation. The target being set is 4% with a +/- 2% band. Of course, it cannot be achieved overnight. The panel has chalked out a transition period—8% for next one year and 6% for the second year.
Still, it will not be easy to achieve. In December, retail inflation declined to 9.9% from 11.24% in November. The last time retail inflation was below 6% was in February 2008. Over the past three years, the average retail inflation has been over 10%.
It’s indeed an ambitious target but as a concept, inflation targeting has not surprised simply because of the fact that RBI has miserably failed in taming inflation in Asia’s third largest economy in past few years. The other important point to note is that food inflation has around 49% weightage in consumer inflation, unlike wholesale inflation, where food inflation’s weight is not even half of this. So, while RBI will be on its toes to keep a close vigil on inflation and meet the target, the government will have to play an equally important role in terms of taming food inflation and the fiscal deficit.
The other important takeaway from the report is its recommendation for setting up a five-member monetary policy committee. The RBI governor will be the chairman of the committee; the deputy governor in charge of monetary policy will be its vice-chairman and the executive director in charge of monetary policy will be a member. The governor and deputy governor will choose two other members from outside. Each member will have one vote and the committee will meet once every two months to decide on the monetary policy. If the committee is not able to achieve the inflation target for three successive quarters, it will be assumed that it has failed. In this case, it will have to issue a statement explaining why it has failed besides proposing actions to achieve the target and laying out a road map over how many quarters it expects the inflation drops to the desired level.
Both Bank of England and the US Federal Reserve have such a committee. Bank of England’s monetary policy committee (MPC), which meets for a couple of days every month to decide on interest rates, has nine members, including the governor of the Bank of England. It is responsible for meeting the consumer inflation target. Five of its members are internal—the governor, two deputy governors, the bank’s chief economist and the executive director for markets—while four external members are appointed by the government. Each member of the committee has a vote to set interest rates at the level they believe is consistent with meeting the inflation target. A representative from the treasury also sits with the committee at its meetings but is not allowed to vote. The purpose is to ensure that the committee is fully briefed on fiscal policy developments and other aspects of the government’s economic policies, and that the chancellor is kept informed about monetary policy.
The federal open market committee (FOMC) of the US Fed holds eight meetings round the year. It consists of 12 members—seven members of the board of governors of the Federal Reserve system, the president of the Federal Reserve Bank of New York, and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis. At its meetings, FOMC reviews economic and financial conditions, determines the stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.
According to the Urjit Patel committee, “monetary policy conduct should be consistent with a sustainable growth trajectory and financial stability" only after establishing and achieving the nominal anchor—the targeted inflation. This means RBI’s top priority will be containing inflation and economic growth will feature on its radar only after this aim is met. If indeed the recommendations of this committee are accepted, RBI will be serious about fighting inflation and the finance ministry’s influence on monetary policy making and interest rate trajectory will disappear.
That’s a welcome change, but a couple of questions remain on the constitution of the committee on who will set the inflation target. In the UK, the government sets the inflation target and MPC follows it. Similarly, four of the nine-member MPC are appointed by the chancellor. Going by the Urjit Patel committee recommendations, RBI will set the inflation target and will have full control over the constitution of the committee. It will be interesting to see how the government reacts to these suggestions.
Banker’s Trust Realtime is a frequent blog by Tamal Bandyopadhyay, who writes a popular weekly column Banker’s Trust.
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
