The good run of inflation targeting

Next year a critical policy review looms for the Indian government: Whether to retain or revise the inflationtargeting framework, a cornerstone of India’s monetary policy for a decade. Critics have been pushing for major changes— ranging from tweaking the target number to redefining the target variable, or even shifting the Reserve Bank of India’s (RBI's) core mandate. However, a major revision now would be unwise because evidence shows that the framework has delivered.

- RAJESWARI SENGUPTA AND VAISHALI GARGA.

India’s formal adoption of inflation targeting in 2016 markeda fundamental shift inthe way monetary policy was conducted. Until then, the RBI had been juggling several goals—rapideconomicgrowth, adequate credit flow, and a stable exchange rate. This left its primary responsibility of controlling inflation somewhat diffused. The 2016 reform fixed that by giving the RBI a single, clear mandate: Keep the inflation rate based ontheconsumer price index (CPI) at 4per cent, give or take 2 percentage points. This framework made the central bank’s objective both clearer and easier to evaluate.

Foracountry that had struggled with high and volatile inflation for years before adopting the framework, this was a major reform. And by the simplest measure, it delivered: The average CPIinflation rate since 2015 has been about half of what it was in the decade before.

That said, lower inflation by itself does not prove that the framework has succeeded. Prices can fall for reasons that have nothing to do with monetary policy — like a global drop in commodity prices or strong agricultural output. In fact, studies show that such favourable shocks played a big role in bringing the inflation rate down soon after the framework was introduced. Critics point to this and argue that the success in this respect was driven more by good luck than bysound policy.