Why Changing Inflation Target Is Fraught With Risks

The RBI has sought views on four key inflation-targeting issues. Maintaining the status quo is recommended, with the focus on creating conditions to consistently achieve the existing 4% target

- JANAK RAJ

The Reserve Bank of India (RBI) recently released a discussion paper (DP) setting out four key issues for public feedback on the numerical inflation target, which is due for review in March 2026. The issues are — whether to target headline or core inflation; the optimality of the 4 per cent inflation target; the tolerance band of +/- 2 per cent around the target; and whether to maintain a central target with a tolerance band or shift to a target range.

The paper is well researched and follows a balanced approach to put all the four issues in proper perspective. These are examined below:

Headline vs core inflation

Core inflation excludes volatile food and fuel items, making it more amenable to monetary policy. However, the targeting of core inflation also raises two key issues.

First, there is always a risk of persistently high food and fuel inflation spilling over to generalised inflation through a wage-price spiral, as the public begins to build higher food and fuel inflation into their expectations. This risk of 'second-round effects' necessitates monetary policy action, even if food and fuel inflation itself is not directly amenable.