Monetary policy decisions by central banks can have far-reaching implications for the economy, investors, savers and borrowers. Between1980 to 1998, RBI adopted operating method of monetary policy ‘monetary targeting with feedbacks’. This method has been later altered pursuant to liberalization of financial markets and opening up of the economy and short-term deviation in the relationship between money, output and prices. From 1998-99 till February 2015, RBI was following Multiple Indicator Approach (MIA), in which a number of macroeconomic and financial variables are considered while deciding the monetary policy rather than a single M3 aggregate as in the past. Under MIA, Central Bank’s rate decisions were taken based on variables like interest rates, rate of return in different markets, foreign trade, Capital flows, inflation, growth, employment, banking stability and the need for a stable exchange rate etc. The multiple indicator approach provided necessary flexibility to RBI to respond to changes in domestic and international economic and financial market conditions. However, in spite of considering other variables, under MIA, the growth in broad money (M3) continues to be used as an important indicator of monetary policy.
The expert committee headed by Dr. Urjit Patel recommended revising the monetary policy framework, and it came up with its report in January 2014. It suggested that RBI abandon the ‘multiple indicator approach’ and make inflation targeting the primary objective of its monetary policy. The Reserve Bank of India (RBI) officially adopted inflation targeting (IT) as a monetary policy strategy in February 2015. Inflation targeting has steadily gained popularity with increasing number countries adopting the frame work.