QUESTION : India needs to move beyond the inflation targeting in its monetary policy. Discuss.
THE RBI TUNES IN TO THE ECONOMY
WHAT ?
RBI’s Policymaking
WHY IN NEWS ?
- The article analyzes how the COVID-19-triggered recession had led to some of the strongly held economic assumptions being revised around the world.
CHANGES IN THE ECONOMIC POLICYMAKING :
- Recently the U.S. Fed declared that the Fed will not let inflation stand in the way of maximising employment.
- The reason for this was that the Phillips Curve, the relationship between inflation and unemployment, may no longer hold in the U.S. economy.
- This is significant, given that the Anglo-American economics has been dominated by Phillips Curve.
WHY THIS NEED FOR CHANGING INFLATION TARGETING :
- Data show that the model that currently guides India’s inflation control strategy may be quite irrelevant.
- This is seen in the recent behaviour of inflation.
- We know that output contracted by more than 23% in the first quarter of this year.
- Despite this staggering decline the inflation rate did not change,
- This was contrary to experience that inflation reflects an ‘over heating’ economy, one growing too fast in relation to its potential.
- This view represents the RBI’s official understanding of inflation, and presumably forms the basis of its policy of inflation targeting.
- It was endorsed by the Government of India when it legislated the modern monetary policy framework to enable the RBI to pursue inflation targeting.
- If the Phillips Curve, which the RBI’s approach internalises, exists, inflation should have decreased as India’s economy contracted during the lockdown.
- The current inflation targeting mechanism had been imagined with developing economies in mind.
- Inflation targeting mechanism is based on the idea that food prices are an important determinant of inflation along with imported inflation.
- Accordingly, a macroeconomic contraction need not lower inflation.
FOOD PRICES :
- Agricultural commodity prices are an indicator of changes in supply and demand, and as such, can detect abnormal conditions that need to be brought to attention.
- Price monitoring supports well-functioning international and national markets through the provision of timely and transparent market information and constitutes a basis for evidence-based decision making and food security strategies.
- Past price volatility events have put in evidence the value of timely market information and analysis in order to mitigate the negative effects on low-income groups of population whose expenditure on food represents a large proportion of their total expenses.
CURRENT SCENARIO :
- Rising food prices: United Nations Food and Agriculture Organisation’s (FAO’s) food price index with reference to a base period (2002-04 = 100) touched 182.5 points in January 2020, the highest since the 185.8 level of December 2014.
- Year on Year inflation rate is also rising: the year-on-year inflation rate based United Nations Food and Agriculture Organisation’s (FAO’s) food price index has also risen steadily from 1.13% in August 2019 to 2.86% in September, 5.58% in October, 9.33% in November, 12.22% in December, and now, 11.33% for January 2020.
- Consumer food price index (CFPI) inflation stood at 99% in August 2019 and climbed to 5.11%, 7.89%, 10.01%, 14.19% and 13.63% in the succeeding five months.
- The wholesale price index for food articles has started rising earlier from 2.41% in January last year to 7.8% in August 2019.
- Retail and wholesale food inflation rates for December 2019 are the highest.
ROLE OF FOOD PRICES IN INDIA :
- A recent working paper of the RBI’s research department suggested that a more eclectic model than the one that underlies inflation targeting does a better job of forecasting inflation in India.
- This model accepts a role for food prices, a possibility that is missed when embracing economic models developed in the western hemisphere, where food prices have stopped trending upwards over half acentury ago.
Food Security
- According to Food and Agriculture Organization ( FAO), food security has basically four pillars:
o Availability: food should be available in sufficient quantity at all times and at all places;
o Affordability: food should be affordable, i.e., people should have economic access (ample income) to buy food;
o Absorption: food should be safe and nutritious that body can absorb for a healthy life; and finally.
o Stability: food system should be reasonably stable, as high volatility in food systems impacts adversely not only the poor but also endangers the stability of political and social systems
PHILLIPS CURVE ?
- The Phillips curve is an economic concept, stating that inflation and unemployment have a stable and inverse relationship.
- The theory claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.
- However, the original concept has been somewhat disproven empirically due to the occurrence of stagflation in the 1970s, when there were high levels of both inflation and unemployment.
CONCLUSION :
The RBI shifting away from its rigid inflation targeting policy is in tune with the time and signals that the central bank is finally alive to India’s economy.
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