Recently, the Monetary Policy Committee has announced its primary focus on inflation or the” inflation targeting. Keeping the high inflationary pressure into consideration, the Reserve Bank of India (RBI) has raised the policy repo rate in order to ensure price stability. The wholesale price inflation has been in the double digits for over 12 months. The consumer price index (CPI) has breached the Reserve Bank of India (RBI)’s upper target of 6%.
Inflation targeting
Inflation targeting is based on the idea that inflation is the result of “overheating” of the economy. It reflects an excess of output over its ‘natural’ level.
Therefore, the central bank raised the interest rate or ‘repo rate’ to control inflation.
It is the rate at which the central bank lends to commercial banks. It induces firms to stay their investment plans, and focus on reducing inventories, and lowering production.
This ensures the contraction of the output takes to the natural level of output (i.e., optimal level). This may lead to a decline in inflation. It ensures full employment and freely functioning labour market.
Issues in inflation targeting in India.
India’s official model of inflation control is based on unscientific a foundation. The Indian model is based on the idea to achieve “natural level of output”. However, it is a theoretical and unobservable phenomenon. The RBI report of 2014 did not mention any empirical validity of this model of inflation.
India’s model is based on the idea that inflation is driven by agricultural goods prices.
Therefore, the production and supply of agricultural goods should be increased. This would cause the Indian economy to expand without inflation. However, whenever there is surplus agricultural production, the government procures food grains at the highest price. This leads to inflation.
The growing per capita income in India has shifted the average consumption basket towards foods rich in minerals, such as fruits and vegetables, and protein, such as milk and meat. But the expansion of the supply of these foods has been lower than the growth in demand for them.
Therefore, the RBI’s present move of increasing the repo rate is not an efficient solution for an agricultural price-driven inflation.
Road ahead
Monetary policy can control inflation by curbing the growth of non-agricultural output. This would in turn lower the growth of demand for agricultural goods. As the demand for agricultural goods slows, so will inflation.
There should be a focus to increase the supply of food other than rice and wheat like fruits, vegetables, milk and meat.
The government should work hard towards increasing agricultural productivity and thereby increasing agricultural production and supply.
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