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Last Updated : Jan 14, 2020 03:45 PM IST | Source: Moneycontrol.com

High retail inflation: RBI must not increase target band and add fuel to fire

Policy flip-flops should be avoided. The new framework should be given time.

Representative image
Representative image

Should the RBI revise its inflation target upwards? The answer is an unequivocal no. Yes, the Reserve Bank of India needs to address growth concerns too and the current rise in consumer price inflation takes rate cuts off the table. However, that is no reason to revise upwards the monetary policy committee’s targets for inflation.

Barring this spike, which most economists say is temporary, consumer price inflation has been broadly stable. It has been a hard-won victory.

The current inflation targeting framework has enough flexibility. After all, it mandates the rate setting committee to keep average inflation at 4 percent but within a tolerance level of 2 percentage points on either side, i.e. in a 2 to 6 percent band.

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Note that in India the nature of inflation is such that we are prone to supply side pressures in food and oil prices. That’s where the flexibility in inflation targeting helps.

Raising the target now will also have an adverse effect on inflation expectations of households. As Lael Brainard, a US central banker, says “Expectations are an important determinant of actual inflation because wage and price behaviour by businesses and households is partly based on expectations of future inflation.”

A higher inflation target could lead to higher inflation by feeding into higher inflation expectations that will then result in higher nominal rates, which in turn could decrease the space to raise interest rates when necessary.

In any case, in India core inflation is stable. The key issue is that of inefficient transmission. The solutions to that riddle lie elsewhere, not in jacking up inflation targets for the central bank.

Moreover, we also need to ask whether food needs to have this high a weightage in the CPI index. Gaurav Kapur, Chief Economist at IndusInd Bank, says it’s perhaps time to reconsider the weightage of food, and especially some items such as vegetables that cause such volatility in inflation numbers.

But that can happen only when the new Consumer Expenditure Survey is out. The government had rejected the draft consumer expenditure survey (CES) report for 2017-18 (which had leaked) as erroneous. No one knows when the next one will be out.

Be that as it may, we should not run scared at the first true test of inflation for the new monetary policy framework. After all, it is barely three years since the system has started. It’s only after a complete cycle is over that we should pass judgement on this system. Till then policy flip-flops are best avoided.

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First Published on Jan 14, 2020 02:57 pm
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