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Friday, April 23, 2021

An unmoving target

Government retains inflation target at 4 plus/minus 2 per cent till March 2026, signalling commitment to price stability

By: Editorial |
Updated: April 2, 2021 8:01:12 am
covid-19 pandemic, covid-19 cases in india, covid-19 active cases, coronavirus cases in India, indian express editorial, indian expressThe inflation target of the monetary policy framework has been kept unchanged at 4 plus/minus 2 per cent for the coming five-year period till March 31, 2026.

In the initial phases of the COVID-19 pandemic in India, retail inflation, as measured by the consumer price index, had surged owing to supply side disruptions stemming from the imposition of the national lockdown. With inflation staying above the upper threshold of the RBI’s inflation targeting framework for most of this period, constraining the ability of the monetary policy committee to ease interest rates further, there was a growing clamour for relooking at the inflation targeting framework. The proposals advocated ranged from shifting from headline to core inflation as the nominal anchor of monetary policy, relaxing the upper threshold of the framework, and incorporating other variables explicitly in the framework. But despite pressures to alter the framework, the Central government, on Wednesday, announced, rightly so, its decision not to alter the framework. The inflation target of the monetary policy framework has been kept unchanged at 4 plus/minus 2 per cent for the coming five-year period till March 31, 2026.

An examination of the trajectory of inflation since the adoption of the targeting framework in 2016 underlines the benefits of this shift. Headline retail inflation has fallen from 7.26 per cent in the pre inflation targeting phase to 3.9 per cent post its adoption (excluding the pandemic period). This downward trend is visible in both core and food inflation. Further, as various studies have shown, even the volatility in inflation has declined over this period. And even though household inflation expectations continue to range above the upper limit of the targeting framework, they are milder as against the pre inflation targeting regime. Further, while there are apprehensions over attaching primacy to inflation management over growth concerns, as this period has shown, the band of plus/minus 2 per cent, along with the period over which the MPC’s success in delivering upon the target is measured, provides flexibility to the committee to manoeuvre as the situation demands.

Changing the inflation targeting framework may have sounded like an attractive proposition now but it would have created considerable uncertainty over the stance of monetary policy. It would have also indicated a lack of fidelity to the objective of maintaining price stability in the economy. And considering that one of the features of the inflation-targeting framework is “anchoring” of inflation expectations, any change that would have signalled greater tolerance by the interest rate setting committee for higher levels of inflation, would have led to an increase in the volatility of prices, thereby destabilising inflationary expectations. These in turn would have a bearing on the long-term consumption and investment decisions taken by economic agents. Tinkering with the framework would have also gone against the very rationale for shifting to the framework — to bring greater accountability and transparency in central bank actions.

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