Inflation Targeting in India

Source-This post on Inflation Targeting in India has been created based on the article “Should RBI target only core inflation? Bad idea” published in “LiveMint” on 6 August 2024.

UPSC Syllabus-GS Paper-3- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context– The article argues that focusing solely on core inflation is inadequate and could negatively impact certain groups. Unstable inflation can unfairly benefit borrowers over lenders and savers. This highlights the need for a central bank that controls inflation effectively.

Inflation targeting works well in America, but India’s economic structure requires a different approach. The Reserve Bank of India (RBI) focuses on overall retail inflation instead of core inflation or labor market conditions

What is the difference in inflation targeting between India and the United States?

1) RBI’s Monetary Policy Approach- The RBI’s monetary policy panel is unlikely to consider labor market data, like the Mint+Shine study that shows 95% of formal-sector employees looking for new jobs in early 2024. This differs from the US Federal Reserve, which closely tracks labor market conditions along with inflation.

2) Sources of Inflation in India- Unlike in the US, where a tight labor market can drive inflation, India’s inflation mainly comes from unstable farm supplies. Therefore, Indian policymakers need to focus more on commodity data than on labor market statistics.

3) Data Reliability – India’s informal economy makes it difficult to collect reliable data, while the US’s formal economy offers clearer insights into how employment affects inflation.

Read More– Inflation In India- Reasons and Solutions

What are the arguments against focusing only on core inflation, which excludes volatile items like food and energy prices?

1) Social and Economic Inequality– Focusing only on core inflation could harm the poor disproportionately by ignoring price stability for essential goods.

2) Agriculture and Food Security- Retail inflation in India is closely tied to agricultural output, showing how much food prices affect overall inflation.

3) International Economic Relations– Oil import costs add to inflation uncertainty in India, showing the country’s vulnerability to global commodity price changes.

Way ahead-The central government should exercise fiscal restraint to support the RBI’s efforts in controlling inflation. It warns that excessive state spending could increase inflation.

Question for practice

How does inflation targeting differ between India and the United States? What are the drawbacks of focusing solely on core inflation, which excludes volatile items such as food and energy prices?