Demand to Rework Inflation Targeting Regime

Source: Indian Express

Gs3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context: Recently the monetary policy committee (MPC) concluded that elevated inflation has constrained it from easing policy rates.

Why there is demand to rework inflation targeting regime?

• Economy slowdown:Since the growth rate is falling that is why question have been raised regarding the inflation targeting framework.
• Growth-inflation quagmire:there is demand for the government to relax the inflation targeting framework to spur growth and demand.

Suggestions:

• Greater tolerance for higher levels of inflation either by adjusting the acceptable range of inflation upwards, or by extending the period over which the MPC has to meet its inflation target.
• Shift from headline to core-inflation as the nominal anchor of monetary policy.
• Incorporate other indicators such as nominal GDP explicitly into the framework.
• Doing away with the inflation targeting framework altogether.

What are possible way outs and their implications?

Easing policy rate:

• It will inject a degree of uncertainty and unpredictability in monetary policy.
• Frequent revisions will destabilise household expectations.
• It will signal a lack of commitment to maintaining price stability.

Shift to a multiple indicator structure:

• This move harks back to the pre-MPC days when there was far greater uncertainty over monetary policy.
• No clarity over the indicator that was dictating the stance of the RBI governor.
• Absence of a well-defined anchor will reduce transparency and accountability from the central bank.

Central bank financing the Centre’s capital expenditure on a regular basis.

• Monetisation should be the last resort: The perils of falling back on this long-discarded policy need to be guarded against.
• Tilt the balance of power in favour of the government: Government owing to its short-term political imperatives will be seduced by the apparent simplicity of this idea without considering its long-term repercussions.
• Channel funds to revenue expenditure:It will lead to a situation wherein the entire budgeted capital expenditure is financed by the central bank.
• Blur the line between fiscal and monetary policy :Giving a central bank a degree of control over the government’s expenditure priorities will allow unelected technocrats to be in charge of determining the expenditure priorities of the government. It will result in the fiscalisation of monetary policy.

Pledge Government shares in companies to avail loans against them:

• It raises questions whether a sovereign should pledge assets to borrow in the local currency.
• In 1991, India had pledged gold for a foreign currency denominated loan not a local currency loan.
• There is not clarity on what will happen if the value of the shares pledged falls below that of the loan.

What is the way forward?

• There is need topush for more external voices in the MPC. For instance, In the UK, a non-voting treasury representative sits with the MPC to discuss policy issues.
• During periods of extreme uncertainty, there is need to adopt some unconventional measures but the principles of sound public policyshould not be discarded.