We are all inflation targeters now, at least since the RBI published the Urjit Patel report on strengthening the monetary policy framework in India. Inflation, at 10 per cent-plus annually for the last six years, is something that definitely needs fixing. But is inflation targeting (IT) the right formula?
In order to understand that important question, one needs to know the determinants of inflation. The US gave up on the notion that the growth of money supply determines inflation sometime in late-1983, when it stopped reporting the eagerly watched money supply numbers on Thursday afternoons.
At that time, US CPI inflation had already come down sharply from its double-digit peak of 13.5 per cent in 1980 to around 3 per cent. After the peak of 5.4 per cent experienced during the Kuwait crisis (oil price) years of 1990-91, US CPI inflation has averaged 2.4 per cent, with a peak of 3.8 per cent in the commodity peak year of 2008 and -0.3 per cent in the commodity trough year of 2009.
Now the US does not have inflation-targeting as a policy, and may have had a loose de facto targeting policy in the last decade. But it would be erroneous to conclude that the US experience supports the targeting idea, just as it would be equally erroneous to conclude that
all the Q (quantitative easing) liquidities have an impact on US inflation. Whether the Qs have an effect on asset prices remains an open question.
Do other country experiences support the notion that IT has been effective? The Patel report documents that 14 countries adopted IT between 1990 and 2000.
The example of inflation in Chile declining from 24 per cent in 1990 to 4.4 per cent in 2007 and inflation in the Czech Republic declining from 10.7 per cent 1998 to 2.9 per cent in 2007 is cited by the report as success stories. India, of course, did not have inflation-targeting but nevertheless CPI inflation did decline from a 11.2 per cent rate in 1990 to 4.4 per cent in 2005 and 6.2 per cent in 2007. The correlation of India’s non-targeted inflation rate with the targeted Chilean and Czech inflation rates is a high 0.73 and 0.66 respectively!
The fact remains that the last six years have witnessed a super, record high 10 per cent-plus CPI inflation rate and the RBI is rightly concerned about bringing it down by whatever means, even a targeting scheme with a dubious record. There are other suggestions, besides targeting, for bringing down inflation. For example, the IMF argues for a raising of repo rates until the cooling is in place.
They further argue, as many others in India, that if only the RBI had been vigilant and raised …continued »