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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                                                                                                                                                PT's IAS Academy: Issues with MPC’s inflation targeting (Nature of inflation to target, and what about growth)
                                                                                                                                                Issues with MPC’s inflation targeting (Nature of inflation to target, and what about growth)
                                                                                                                                                Excellent study material for all civil services aspirants - begin learning - Kar ke dikhayenge!
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