BackGrowth concerns to guide inflation target review
The central government, in consultation with the Reserve Bank of India (RBI), is set to review the inflation target under the monetary policy framework next month. The target will be in place for the coming five years, starting April. Mint explains.
PremiumThe central government, in consultation with the Reserve Bank of India (RBI), is set to review the inflation target under the monetary policy framework next month. The target will be in place for the coming five years, starting April. Mint explains.
What is an inflation targeting framework?
In 2015, the Centre and RBI signed a historic monetary policy framework, setting out an explicit, but flexible, inflation target for the central bank. The regulator was tasked with bringing consumer price inflation below 6% by January 2016, and within a band of 2%-6% with 4% as the mid-point for 2016-17 and subsequent years. In May 2016, the RBI Act was amended to offer a legal basis for the implementation of the flexible inflation targeting framework. This provided for a rate-setting six-member MPC, chaired by the RBI governor. The MPC was given the policy tool of repurchase rate to hold inflation within the target.
How has the policy framework fared?
The explicit mandate of the MPC under the inflation-targeting regime has been to maintain price stability, while keeping in mind the objective of growth. If we leave out the pandemic period, when supply disruptions pushed retail inflation above RBI’s tolerance level of 6%, the framework seems to have acquitted itself well. From double-digit inflation that we saw prior to 2014, price gains have remained moderate. An inflation target has largely helped anchor inflation and its expectations. The framework’s record on growth has been less cheery, though, but that can’t be solely ascribed to the inflation-targeting regime.
How does the regime add to growth vs inflation debate?
The interest rate set by RBI has a bearing on money supply and economic activity. A higher interest rate makes borrowing costlier, hurting demand for credit needed for investment and consumption. While the framework has helped curb inflation, a sign of its success, a restrictive monetary policy has been seen by many to have adversely impacted economic growth.
What policy changes are being sought?
Many experts have argued that the MPC leaned excessively towards price stability, first raising rates and then keeping them elevated even when inflation turned benign, and almost abandoning growth as its objective. But, RBI’s caution must be viewed in context of expansionary policies instituted following the 2008-09 crisis that fuelled runaway inflation later. Now, some want the target raised, while others want a growth rate target to be brought in. Still others want the inflation-targeting framework itself junked.
What changes are likely at the review?
The law provides for only a review of the inflation target, and not the framework itself. So, the inflation targeting regime will stay. A higher inflation target is possible, as that would give RBI headroom to cut rates and boost growth. RBI has been in favour of maintaining a status quo. High inflation, though, leaves the poor worse off and can leave governments vulnerable. To be sure, growth has declined not just because of high rates in the initial stages of the framework, but also due to demonetization and GST shocks. And then came covid.
Milestone Alert!Livemint tops charts as the fastest growing news website in the world 🌏 Click here to know more.
