Inflation Targeting

Inflation targeting as a framework for operating monetary policy has become quite popular ever since the Reserve Bank of New Zealand formulated it for the first time in early 19 90s. Presently, interest targeting is being practised in about 34 countries � 21 industrialized and 13 emerging countries with varying degrees of success. The rationale behind inflation targeting is that if the central bank of a country sets an inflation target and then adjusts its monetary policy accordingly, the economic agents would conduct their productive activities without being distracted by relative price distortions. Hence, there will not be any adverse effects on output and employment.

The whole debate on inflation targeting has revolved around the possible shape of the so-called Phillips curve. Reactive inflation targeting owes its origin to the evaporation of the relationship between inflation and unemployment � the famous Phillips curve which explained on the basis of UK unemployment and price data in the 1960s that a percentage reduction in unemployment would lead to a certain rise of some magnitude in the inflation rate. However, the relationship between inflation and unemployment broke down during the 1970s. Its place was taken by the concept of non-accelerating inflation rate of unemployment (NAIRU) introduced by Milton Friedman and Edmond Phelps, which ruled out reliance on the inflation-unemployment trade-o. Any expansionary monetary policy would trigger a pressure from the workers for raising their wages and hence inflation without any impact on the level of unemployment.

The policy of inflation targeting is a sort of commitment and communicative device constructed with the prior agreement with the government, thereby demarcating the fiscal and monetary policy domains. If the forecast inflation rate exceeds the targeted inflation rate, the central bank steps up the short-term interest rate, so that the forecast rate remains close to target and vice versa.

However, recent developments arising mainly from growing globalization seem to have revived the inflation-unemployment trade-off, indicating that the non-accelerating rate of unemployment is moving downward without any pressure on prices.

What is Driving Protein Food Prices Higher in India?

Some recent articles suggest that a change in dietary habits towards protein-rich foods has been a key drive of high food price inflation in India (Subbarao 2011, Gokarn, 2011); they also suggest that this is a result of (a) rising nominal rural wages helped by the expansion of the Mahatma Gandhi National Rural Employment Guarantee (MGNREGA) scheme; (b) inadequate producer supply responses relative to demand; and (c) shocks from global from global food inflation, as India integrates with the world. A more nuanced view is possible on each factor.

Protein inflation

rising prices of pulses, fish, meats, eggs, and milk � is evident (e above). But the causes are more complicated than rising spending among low-income rural households. First, the shift to more expensive proteins is very unlikely to be from rising incomes in rural areas from income groups benefited by the MGNREGA. Incomes of average rural households in the bottom two (MGNREGA target beneficiaries), for example, would have to jump to t hose of the rich farmer category, the sixth decline in rural areas, for a modest `100 monthly increase in per capita spending on protein-rich items by those households. The average (5th decline) urban household, by contrast, spends as much as seven times more than the bottom rural decline on protein-rich foods, and could achieve the same increase with a much more modest increase in incomes.

Fast-growing urban consumers benefiting, for example , from the government�s sixth pay commission pay hikes in 2008-9 and even larger private-sector salary hikes after a spectacular urban growth spurt during 2004-8, are a far more likely source of rising demand. Consider milk consumption. Monthly per capita liquid milk consumption in urban areas (from National Sample Survey [NSS] data) is far higher (5.4 liters) than in rural (4 liters); milk products (powder, solids, paneer, cheese, others) consumption is overwhelmingly urban and fastest growing (over 12 per cent per annum) � a pattern seen worldwide �whereas much of rural consumption is in own use, non-market forms that only affect market prices from a distance.

Written by princy

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