Notes

Abandoning inflation targeting could be counterproductive

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Last Updated22/08/2024

India's inflation targeting regime has been largely successful in stabilizing the economy and anchoring inflation expectations.

India's inflation targeting regime, a key component of the Reserve Bank of India’s (RBI) monetary policy framework, has been largely successful in stabilizing the economy and anchoring inflation expectations
According to a recent research paper. Authored by economists Barry Eichengreen from the University of California, Berkeley, and Poonam Gupta from the National Council of Applied Economic Research (NCAER), the paper titled "Inflation Targeting in India: A Further Assessment,".

Implemented in 2015 through a government-RBI agreement, India's inflation targeting regime aimed to control inflation by setting a clear target for the Consumer Price Index (CPI) inflation rate. The target was set at 4%, with a tolerance band of +/- 2 percentage points.
The paper highlights that inflation targeting has met its objectives on almost all fronts. Furthermore, inflation expectations are better anchored, and the transmission of monetary policy has become more effective, leading to improved economic outcomes.

The research paper argues strongly against abandoning the inflation targeting regime in favor of a more discretionary approach. It warns that such a move could introduce uncertainty and instability, making economic management more challenging.
The paper also counters earlier criticisms that the inflation targeting regime has made the RBI overly hawkish or reactive. It notes that the RBI has shown flexibility in its approach, adjusting the key policy rate 17 times since September 2016.

The paper supports the idea, recently advocated by Chief Economic Advisor V. Anantha Nageswaran, that monetary policy should focus more on core inflation, which excludes food and energy prices, rather than headline inflation.