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Inflation Targeting

Topics Covered: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Inflation Targeting:


Context:

The Reserve Bank of India, in the Report on Currency and Finance for FY21, has said the current inflation target of 4% with a +/-2% tolerance band is appropriate for the next five years.

Important observations made:

Trend inflation had fallen from above 9% before flexible-inflation targeting (FIT) to a range of 3.8-4.3 % during FIT, indicating that 4% is the appropriate level of the inflation target.

An inflation rate of 6% is the appropriate upper tolerance limit for the target.

A lower bound above 2% can lead to actual inflation frequently dipping below the tolerance band while a lower bound below 2% will hamper growth, indicating that an inflation rate of 2 % is the appropriate lower tolerance bound.

Outcomes of FIT:

  • During the FIT period, monetary transmission had been full and reasonably swift across the money market but less than complete in the bond markets.
  • While there has been an improvement in transmission to lending and deposit rates of banks, external benchmarks across all categories of loans and deposits could improve transmission further.

Flexible Inflation Targeting Framework:

Now there is a flexible inflation targeting framework in India (after the 2016 amendment to the Reserve Bank of India (RBI) Act, 1934).

 Who sets the inflation target in India?

The amended RBI Act provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once every five years.

Current Inflation Target:

The Central Government has notified 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016, to March 31, 2021, with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.

InstaLinks:

Prelims Link:

  1. What is the current inflation target?
  2. Who sets it?
  3. What is the monetary policy committee (MPC)?
  4. Functions.
  5. Composition.

Sources: the Hindu.