RBI and Inflation Targeting

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17 May RBI and Inflation Targeting

Posted at 17 May 2021 in Current Affairs by
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 GS PAPER-3, ECONOMY

SOURCE- rbi.org

Context

RBI is the main decision maker for the country’s financial system and is mandated with ensuring its stability. RBI currently uses inflation targeting as key to monetary policy. Monetary Policy Framework Agreement 2015 between RBI and the central government mandates RBI to contain Consumer Price Inflation (CPI) within 4% with a band of (+/-) 2%.

Inflation Targeting-

Limitations of dependence on monetary policy based on inflation targeting Easy money policy is needed to increase economic activity during slowdown. This is done by keeping the interest rates low. Thus, RBI needs to balance inflation targeting and accelerated economic growth.

  • For example, even though the current inflation rate is at around 3%, there is a slowdown in the economy and GDP growth was at a 6 year low of 5% in the April-June 2019 quarter.

However experts say that Inflation targeting cannot ensure stability in the economy.

For ex: It failed to detect financial crisis situations like IL&FS default and the NPA (Non Performing Assets) crisis in the banking industry.

Scholars argue that Inflation targeting in India has coincided with a substantial rise in the real policy rate. This has been accompanied by declining borrowing in the formal sector likely affecting investment and thereby growth.

  • Inflation in developing markets such as India is very sensitive to exogenous shocks like global oil prices, a weaker rupee and a poor monsoon.
  • The 2008 Global Financial crisis of 2008 showed that monetary policy defined by inflation targeting can no longer be treated as the centerpiece of macroeconomic policy.
  • Fiscal policy should be the primary tool to stabilize the economy. Better policies targeted at efficient taxation and government spending should be used to influence the economy in the long run.

 

Way Forward

RBI not only needs functional independence, but it needs to follow a more pragmatic financial policy. In this scenario, RBI’s role must now be redefined through a recalibrated monetary policy, which is in sync with changing economic conditions.

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