QUESTION : India needs to move beyond the inflation targeting in its monetary policy. Discuss.






RBI’s Policymaking




  • The article analyzes how the COVID-19-triggered recession had led to some of the strongly held economic assumptions being revised around the world.




  • 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.




  • 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.




  • 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.




  • 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.




  • 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





  • 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.




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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