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Re-look inflation targeting PDF Print E-mail
Thursday, 15 June 2017 00:00
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The government, too, has a role in working towards this

 

 

With farmers agitating over low prices, and the government needing to make good on its promises to raise their incomes/profits, chances are the government will start raising the MSP of various crops by larger amounts than in the past, and possibly also increase the number of crops covered by this. Indeed, if the past is anything to go by, prices of certain items like onions could go up sharply over a period of time—after a bumper crop causes prices to crash, farmers sow less the next season, as a result of which, prices shoot up. If food inflation starts rising, especially if there is a return of pricing power in the manufacturing sector, the central bank will find another reason to not lower rates since, though core inflation has also fallen steadily, the really sharp reduction in inflation has been the result of food inflation falling sharply.

Though this newspaper has been a critic of inflation-targeting for a variety of reasons, now that it has been accepted, it is unlikely to be jettisoned in a hurry, especially given how the government has tom-tommed its new policy. It is, however, important to keep in mind, there were always two players in the inflation-targeting game, the government and RBI. While RBI was to keep a check on inflation, this was contingent on the government doing its bit. Part of this was keeping a lid on deficits—with the states splurging, it is not clear that is happening. Two, given the importance of food inflation—food items are 46% of the CPI—the government’s job was to reduce supply-side bottlenecks that cause food inflation to spike. Keep in mind, if food inflation is rising at 6%, to stick to the 4% target means non-food inflation can rise by only around 2%; if food inflation is 10%, there has to be a 2% deflation in non-food items. Further, with taxes comprising around half the retail price of fuels like petrol and diesel which have a high share in the CPI basket, surely government policy cannot be to keep taxes high—but that is what it is today. In other words, even if we are to stick to inflation-targeting, surely this has to be done in a more sensible fashion with RBI concentrating on core-inflation instead of on overall CPI—in which at least half the basket is impervious to monetary policy. With inflation at 2.2% in May, it would appear RBI is winning the battle and inflation-targeting is working—as food inflation starts rising, the folly of this policy will become evident. The monetary policy committee would do well to ponder over this.

 
 
 
 
 

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