Central bank credibility is key to achieving a Goldilocks economy

RBI must achieve its 4% inflation target and estimate India's real equilibrium rate of interest well in the process of doing so

- NIRANJAN RAJADHYAKSHA

Credibility is an asset that is patiently accumulated over long years. It can then be put to work when normal rules of behaviour must be suspended during exceptional times. What is true for individuals is also true for central banks, say after a financial crisis or a pandemic. Credibility matters when steering an economy after a shock. That is one reason why disinflations are often less painful in countries with credible monetary policy authorities. The interest rate increases needed to stabilize inflation expectations are less severe when citizens have higher levels of trust in the central bank.

A statement by Reserve Bank of India (RBI) Governor Shaktikanta Das in the June meeting of the six-member monetary policy committee (MPC) needs to be seen against this backdrop. He said that the recent decline of consumer price inflation back within the acceptable range is a job half-done, and “we have a way to go to align headline inflation with the 4.0% target on a durable basis." Markets quickly adjusted their expectations about when RBI will cut interest rates even as inflation trends down; few now expect a rate cut before the next calendar year begins. It is called a ‘hawkish pause’ these days.