Arguments against inflation targetting so far are just a rehash of old impressionistic views

Retail inflation, as measured by the Consumer Price Index (CPI), was 7.35% in December, the highest level recorded in over five years.

A fallout was the reemergence of questions on the efficacy of flexible inflation targetting monetary policy which was, for all practical purposes, initiated in 2014 and given legislative sanction and an institutional structure in 2016.

The legislation mandates an inflation target of 4% subject to a band of two percentage points on either side. Failure is defined as monthly inflation falling outside the band for three consecutive quarters. Therefore, we are nowhere close to failure.

Flexible inflation targetting, or FIT, should be subject to re-examination at intervals. All policies evolve over time. But, thus far, the carping over FIT has been a rehash of old and unconvincing arguments.

There is not one meaningful argument against FIT after almost six years.

Let us consider some common complaints.

Is CPI the right measure for FIT? India’s savings come primarily from households. Any inflation targetting measure using policy rates as a tool cannot afford to ignore inflation experienced by households.

CPI is constructed on the data  provided by NSSO consumer surveys. FIT, which was the outcome of an expert committee headed by then RBI deputy governor Urjit Patel, considered and rejected targetting only core inflation. The committee explained that as expectations play an important in inflation, targetting the headline inflation would be ideal.

Is the inflation target and band too restrictive? The target and band were decided on the basis of research. They will be reviewed at regular intervals. Nothing is cast in stone.

Does FIT limit monetary policy? It doesn’t because the legislation for FIT unambiguously lays out that policy should be crafted keeping economic growth in mind. This is the reason RBI’s monetary policy committee changed its approach a year ago and we saw a reduction in policy rate by 1.35 percentage points.

FIT, like all other approaches, needs to be critiqued. Hopefully, with rigour and not impressionistic views.

DISCLAIMER : Views expressed above are the author’s own.

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