Inflation targeting in India: issues and prospects

Abstract

This paper evaluates the case for inflation targeting (IT) in India. It states the objectives of monetary policy in India and argues that, with widespread poverty still present, inflation control cannot be an exclusive concern of monetary policy. The rationale for IT is spelt out and found to be incomplete. The paper provides some evidence on the effects of IT in developed and transition economies and argues that although IT may have been responsible for maintaining a low inflation regime, it has not brought down the inflation rate itself substantially and or changed the volatility of the exchange rate. Output movements in transition countries adopting IT have been higher than in developed market economies. I discuss India's experience with using nominal targets for monetary policy and why India is not ready for IT. Further, even if India's central bank wanted to, it could not pursue IT because the short-term interest rate does not have a significant effect on inflation. The paper concludes by listing monetary policy options for India.inflation targeting, economic growth, India,

Conducting Monetary Policy in South Asian Economies: An Investigation

“…Positive increases in the output gap represent a rise in actual output relative to potential output.24 In 2006 committee on full convertibility of capital account firmly recommended to the RBI that RBI should maintain a monitoring band of +/-5 percent around the real effective exchange rate and should intervene as and when the real effective exchange rate moved outside this band[RBI (2006)].25 The RBI adopted multiple indicator approach in 1998 to maintain (i) a stable inflation environment, (ii) appropriate liquidity conditions to accelerate economic growth, (iii) maintain orderly conditions in the foreign exchange market to avoid excessive volatility in the exchange rate, and (iv) stable interest rate[RBI (2002);Jha (2008)]. …”

The Strategic Implication of Monetary Control: An Empirical Investigation of the Indian Economy

“…One of the most important factors that cannot be ignored here is that the financial markets should be sufficiently developed so that the global capital markets have sufficient confidence in them and that they facilitate the adoption of a flexible exchange rate regime (Jha, 2006). These findings show that inflation is strongly correlated with major economic variables like interest rate, money supply, real effective exchange rate, and past inflation rate.…”

A Monetary Policy Model without Money for India

“…Employing dynamic OLS, they found that while the coefficient on the output gap is statistically significant and with the correct sign, the same is not true for the coefficient on the inflation term and this result does not change under an open economy Taylor rule. Accordingly, they concluded that an inflation targeting framework is inappropriate for India, an inference that is also arrived at by Singh (2006) and Jha (2008). A comprehensive analysis of monetary policy rules across different specifications in both backward-and forward-looking versions is undertaken in Singh (2010).…”