Issues with MPC’s inflation targeting (Nature of inflation to target, and what about growth)

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 Issues with MPC’s inflation targeting (Nature of inflation to target, and what about growth)

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• Reviewing the MPC framework: The RBI's Monetary Policy Committee framework is running since Oct 2016 and is now up for review. Its sole target was inflation control (CPI-based) to 4 % per annum, with 2 per cent on either side. But in CPI basket, 85% of the weight is unaffected by interest rates in economy!
• What it did: The MPC kept reducing the repo rate (so released more liquidity) even when inflation was not reducing. Five issues are involved -

1. FIRST - Inflation target itself - It was fixed at 4 per cent, but how and why? From 2012-13 to 2015-16, inflation was 7.54 %. Then it was 3.8%. CPI inflation for Industrial Workers (IW) (2001) was 8.5% for 2005-2016. Then it became 4.2%. It never earlier was lower than 4%. So are the new lower readings due to chance, rather than structural reasons?
2. SECOND - Which inflation to target - Core or Headline? Logic given is that monetary policy doesn't affect food and fuel inflation (supply-side factors) so target Core inflation only. Prior to MPC coming, Core inflation was higher than 4 %. Non-core had moderated overall inflation after 2016. So could MPC have targetted core CPI? Divergent trends - often core went up and non-core came down, but presently it's the reverse (non-core is up and core is down).
3. THIRD - MPC decides policy six times a year, and uses monthly inflation y-o-y numbers (combined with outlook for future). Outlook often is not aligned with present decisions. There is no surety of what MPC will do - it may not necessarily raise repo rates if inflation has gone up.
4. FOURTH - Is growth also an issue? Or only inflation is? MPC keeps talking of output gap & demand weakness (so interest rate action stimulation). So why not formally include growth mandate? (Hint - The FRBM gives an escape clause if GDP goes below 2% compared to past four quarters, so can MPC too have such flexibility?)
5. FIFTH - MPC is not reviewing past actions and their impact. It should, because a time-frame for transmission and impact on inflation must be decided. Onion prices rising or falling, and their causal impact, needs to be checked.
6. SIXTH - Increase the size of MPC team, and add one from industry, one from banking, and one from public (to talk about savings rate).

• Diversity and rotation: As the situation on ground is constantly changing, we need more diversity, and more opinions, not less.
• Summary : The Monetary Policy Committee (MPC) needs a whole new approach, tempered with the learnings over the years.

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