If inflation remains elevated, Monetary Policy Committee could lose credibility. This must be avoided

What is the news?

RBI Governor has expressed optimism over the state of the economy. Speaking at an event organized by The Indian Express and the Financial Times, he noted that the economy will witness a sequential improvement in the second quarter of this year.

What does the recent GDP data indicate?

Recently released GDP data suggests that the economic impact of the second wave of the pandemic was less severe than last year. In the first quarter of the current year, the economy was about 9% lower than its pre-Covid levels.

In the period thereafter, parts of the economy are near their pre-Covid levels, though the contact intensive services sectors continue to lag.

However, the second quarter numbers will be distorted owing to the base-effect — the economy had contracted by 7.4% in the same period last year and there is also considerable uncertainty over the momentum of the recovery.

Equally uncertain is the extent to which the distress in the informal economy has receded.

What concerns are being raised wrt RBI’s current policy?

Concerns are being expressed over the continuing accommodative policy stance of the central bank in light of retail inflation continuing to stay elevated.

RBI’s view: RBI Governor defended the stance, pointing out that the Monetary Policy Committee (MPC) was taking advantage of a flexible inflation targeting regime and stated that instead of the exact target of 4%, the MPC is operating within the band of 2-6%.

What is RBI’s view on policy normalisation?

On policy normalisation, RBI Governor said that the RBI/MPC are very closely watchful of inflation hinting that the RBI is unlikely to withdraw the accommodative measures in a hurry, unless it sees a durable recovery taking shape.

RBI needs to be careful of the costs of ignoring inflation. If inflation continues to stay elevated, the MPC risks losing credibility vis-a-vis achieving its objective of price stability. This must be avoided.

Source: This post is based on the article “If inflation remains elevated, Monetary Policy Committee could lose credibility. This must be avoided” published in The Indian Express on 11th September 2021.