In recent news, the Indian Government has chosen to maintain its inflation target at 4%, plus or minus 2 percentage points, for the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) over the next five years. The RBI also recommended this same inflation target in its Currency and Finance report for the fiscal year 2020-21.
Key Points: Inflation Control and Objective
To suppress the rise in prices, the Centre instructed the RBI in 2016 to stabilize retail inflation at 4%, with a 2% margin on either side for a term concluding on 31st March 2021. The Consumer Price Index (CPI) monitors changes in the retail prices of goods and services that households typically purchase for everyday consumption. For the period between 1st April 2021 to 31st March 2026, the inflation target under the Reserve Bank of India Act, 1934, remains identical to that of the past five years.
Historical Context: Central Bank Strategy
Back in 2015, the central bank and government agreed on a policy framework focused on ensuring price stability while keeping an eye towards growth. The Flexible Inflation Target (FIT) was consequently adopted in 2016. The Reserve Bank of India Act, 1934, was revised to legislate a statutory foundation for the FIT framework. This modified Act permits the government, following discussions with the RBI, to establish the inflation target every five years.
Inflation Targeting: Types and Aim
Inflation targeting is a central banking strategy that adjusts monetary policy to achieve a predetermined annual inflation rate. It is renowned for introducing greater stability, predictability, and transparency in making monetary policy decisions. There are essentially two types:
– Strict Inflation Targeting: Implemented when the central bank’s exclusive concern is to keep inflation as near to a specific target as possible.
– Flexible Inflation Targeting: Deployed when the central bank also considers other factors, such as stability of interest rates, exchange rates, output, and employment.
Monetary Policy: Definition and Application
Monetary policy is a macroeconomic strategy designed by the central bank. It includes managing money supply and interest rates and serves as the demand-side economic policy used by a country’s government to achieve macroeconomic goals like inflation, consumption, growth, and liquidity.
In India, the RBI’s monetary policy aims to manage money quantity to cater to different sectors of the economy and stimulate economic growth. The RBI employs open market operations, bank rate policy, reserve system, credit control policy, moral persuasion, and various other instruments to implement its monetary policy.
Monetary Policy Committee: Role and Composition
The Monetary Policy Committee (MPC) is a statutory framework established under the Reserve Bank of India Act, 1934, with the primary aim of maintaining price stability while considering the objective of growth. The Governor of the RBI serves as the Chairman of the committee. The MPC sets the policy interest rate (repo rate) needed for achieving the inflation target of 4%. The establishment of the MPC was recommended in 2014 by a committee led by then-deputy governor Urjit Patel.
