Does the Govt's Inflation-Targeting Make Sense?

Tue, 9 Aug Pre-Open

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It came as a shocker to us when RBI governor Raghuram Rajan announced he wouldn't be serving another term at the central bank. We believed that the RBI was in good hands under his leadership. So, Rajan's exit from RBI next month will be a big loss for us.

But there's some positive news we came across recently. No, Rajan hasn't changed his mind. He is not staying back. But his legacy will. Let us explain how.

Recently, the government announced an inflation target of 4%, plus or minus 2%. The Monetary Policy Committee (MPC), which is being set up, will have to adhere to the target till 31 March 2021.

Last year, the government and RBI had agreed on a monetary policy framework with the inflation target set. However, it didn't have legal backing. So the latest move by the government does validate Rajan's inflation-fighting policies.

Let's examine the pros and cons of the government's inflation-fighting policy...

The idea is said to have a profound impact on the poor and less privileged. With inflation remaining in a defined range, they would be better-off than they are now.

Other benefit of inflation-targeting is that it gives the central bank a sense of clear focus. It maps out the actions that need to be taken in order to maintain inflation within the specified target over a specific span of time.

Further, as per an article in Livemint, inflation-targeting promises the credibility of central bank. Over the period, if the target is realised, it communicates to the common man that the central bank has the track record of achieving the price stability that it promised. This, in turn, could lower the rage towards inflation volatility in the markets.

For the negatives, we have following points in discussion.

The major concern on the issue is the underlying metric used to measure inflation. The metric chosen for the inflation-targeting mechanism is the consumer price index (CPI). This is worrisome because CPI comprises of a volatile series. It has more than 50% composition of food and fuel, which not only tend to be volatile in nature, but also have little bearing with monetary policy.

Second, we have the question of autonomy. The target can be achieved only if the RBI is given operational freedom. It should be free of government's intervention and the political drama. With Raghuram Rajan not staying back as the RBI governor, his successor should continue his legacy. Whoever he or she is, the next governor should bat for the country and not just for the government. Only then would the inflation target remain in check.

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