Inflation targeting: Government needs to pitch in

April 2, 2015

(Any opinions expressed here are those of the author and not necessarily those of Thomson Reuters)

Inflation has halved in the past two years, but apprehension that it may rise again has led the government and the RBI to adopt inflation targeting.

A labourer rests on sacks of onions inside a supply truck, at a wholesale vegetable market in Agartala, March 16, 2015. REUTERS/Jayanta Dey/FilesInflation control is the RBI’s central responsibility, but that does not absolve the government of its role in taking steps to correct the imbalance between food consumption and food production, which is the main source of inflation in India.

For now, the government will tolerate 6 percent inflation. But from next year onwards, inflation will have to be within a range of 4 percent, plus or minus 2 percent.

Inflation is a highly sensitive political issue and it is no wonder that the finance minister was eager to minimize the government’s role in the framework agreement signed with the RBI.

Food inflation has been the primary source of inflation measured either by WPI or CPI, and RBI’s monetary policy has little control over it because food is not purchased by the consumer from borrowed money. It is precisely for this reason that the doubling of repo rate in the past did not slow down inflation. That goes for crude oil as well, whose prices are decided internationally depending on overall demand and supply conditions. No change in interest rate by the RBI can impact oil prices.

But an increase in interest rate is necessary to prevent real interest rate from turning negative. This is why the country witnessed the strange combination of high inflation and low growth, which made monetary policy ineffective.

The central bank’s policy can work only with the combination of high inflation and high growth or low inflation with low growth, which makes the government’s role crucial. The centre needs to give greater attention to balanced food production and food consumption.

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