Monetary Policy: Inflation targeting

In January 2014, the expert committee headed by Dr. Urjit Patel recommended revising the monetary policy framework, and it came up with its report. In the report it was suggested that RBI must abandon the existing ‘multiple indicator approach’ and make inflation targeting the primary objective of its monetary policy. As per the recommendation, the Reserve Bank of India (RBI) officially adopted inflation targeting (IT) a technique targeting to control the general rise in the price level as a monetary policy strategy in February 2015.

Inflation Targeting (IT) is a monetary policy framework where a central bank estimates and makes public a projected, or “target,” inflation rate and then attempts to steer actual inflation toward that target, using such tools as interest rate changes. The periodic unambiguous acknowledgement of inflation rate that low or stable inflation constitute the long run goal of monetary policy.

The Reserve Bank of India announces the periodic inflation rate in the country by its bi-monthly monetary policy statement.  With the fixed target of 4% to be followed till March 2021, the Reserve Bank of India adopted to follow a “flexible IT” framework which gives the central bank a discretion to respond to shocks such as a growth slowdown in the short run and meet the inflation target in the medium run. For the reason that of inflation targeting’s medium-term focus, flexible IT policymakers need not feel compelled to do anything to meet the gap between the forecast inflation rate and a pre-announced target rate on a period-by-period basis. Thus, inflation targeting provides a rule-like framework within which the central bank has the discretion to react to shocks.

The success of inflation targeting monetary policy requires with some degree of independence to Central Banking Authority. No central bank across the world can be entirely independent of government influence, but it must be free in choosing the instruments to achieve the rate of inflation that the government deems appropriate. Further, success of the policy laid with that it should not be mixed with other indicators like wages, unemployment and exchange rate etc.