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Need of Continuing with Inflation Targeting

Synopsis: Inflation is still a big worry for policymakers. That is why the government is still willing to retain the inflation targeting.

Introduction

The Finance Ministry will continue with the inflation-targeting framework. It will guide the interest rate decisions of the RBI’s Monetary Policy Committee over the five-year period.

  • The Department of Economic Affairs notified that the inflation target for the next five years ending on March 31, 2026, will be 4%. The upper tolerance level will be 6% and a lower tolerance level will be 2%.
  • It means no change has been introduced to the framework.

How will the announcement by the department of economic affairs be perceived?

The announcement indicates that price stability will be the base for all macro-economic development.

  1. Firstly, the announcement is a relief as inflation pressure is rising. The recent Consumer Price Index data show retail inflation increased by almost 100 basis points in February. Food and fuel costs remain volatile till now.
    • As per IHS Markit India Business Outlook survey companies are planning to raise selling prices in the coming 12 months to cope with rising costs of raw materials.
  2. Secondly, the RBI’s officials have emphasised on the need to preserve the flexible inflation targeting framework. In a paper titled ‘Measuring Trend Inflation in India’, Deputy Governor Michael Debabrata Patra, and a colleague highlighted the importance of guaranteeing the inflation target.
  3. Thirdly, there has been a steady decline in trend inflation to a 4.1%-4.3% band since 2014. The officials said that a target lower than the trend had the risk of imparting a deflationary bias. This bias would reduce economic momentum.
    • A goal much above the trend could cause expansionary monetary conditions that would likely lead to inflation shocks.
The conclusion

The RBI’s researchers Report on Currency made it clear that the framework had served the economy well. The government’s economic officials have noticed that it will certainly reassure investors and savers that inflation remains a central concern for all policymakers.

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