RBI, inflation targeting, and the limits of monetary policy

Source– The post is based on the article “RBI, inflation targeting, and the limits of monetary policy” published in The Indian Express on 26th September 2022.

Syllabus: GS3- Indian Economy

Relevance– About inflation

News– The article explains the new statutory framework for inflation targeting. It also explains the reason behind high levels of inflation in recent times and implications of this.

What is the statutory framework for monetary policy?

The Centre, under RBI Act, 1934 has fixed the CPI inflation target at 4% with an upper tolerance limit of 6%.

Read more about Inflation Targeting.

With the enactment of inflation targeting framework, RBI was entrusted with the responsibility of meeting this target (“accountability”). It was given “independence” for the conduct of monetary policy.

Has RBI been able to achieve its target?

Inflation in 2022 has been above 6% every single month from January to August.

During the present government’s first term, inflation was above 6% only for one month after a new inflation targeting framework came into existence.

During the second term, it has exceeded its target in 21 months out of 41 months.

Why RBI needs help of government in controlling inflation?

Food and beverage items have a combined 45.86% weight in the overall CPI (Consumer Price Index).

There has been consistent increase in the general CPI as well as the consumer food price index (CFPI).

During the present government’s first term, average food inflation was low, thus RBI was able to control the inflation. Whereas, during the 2^nd term, food inflation has been high, therefore the inflation has been high.

Average weight of food items in CPI is 45% in India. While, it is 10-25% in developed countries.

The food inflation cannot be controlled through demand side measures like increase in repo rate. There is need for supply side measures.

Therefore, RBI has to be dependent on the government for supply side measures. For example, the government banned wheat exports in May this year. It impacts the independence of RBI in conducting monetary policy.

Inflation control cannot be left to the RBI alone. It needs cooperation between the government and the RBI.