Syllabus: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
Context
- India’s FIT mandate targets inflation at 4% ±2%, ending March 2026.
- The RBI released a discussion paper seeking views on the framework.
- Key questions include headline vs core, acceptable inflation, and the inflation band.
Why inflation control matters
- High inflation acts as a regressive consumption tax on poorer households.
- Inflation volatility damages savings and misdirects productive investment.
- Controlling inflation preserves macroeconomic stability and long-term growth prospects.
Headline versus core target
- Headline inflation reflects overall price changes, protecting the poor.
- Food inflation may not be purely a supply shock, contrary to assumption.
- Without money supply expansion, aggregate prices cannot sustainably rise.
- Food inflation can produce second-round effects, raising core inflation eventually.
- Therefore, monetary policy should include food inflation within its mandate.
Acceptable inflation level
- Historical analysis suggests an inflection point near 4% inflation.
- Short-run Phillips trade-offs are limited and do not hold in long run.
- Preliminary simulations indicate below 4% as a reasonable target for India.
- Fiscal and external conditions must be considered before firming the target.
Inflation band and governance
- The ±2% band has given the RBI useful operational flexibility.
- Staying persistently near the upper limit defeats the framework’s intent.
- Evidence shows growth declines sharply when inflation exceeds 6%.
- FIT must be complemented by prudent fiscal policy and FRBM adherence.