Headline Inflation, And Not Core, For Credit Policy

When one looks at policy targeting, it has to be headline inflation as it drives decisions on savings and investment

- By MADAN SABNAVIS

THE CREDIT POLICY TARGETS headline inflation, which is the practice in almost all countries. The Monetary Policy Committee (MPC) also targets the same in India as this has been the mandate from the start and not changed when it was reviewed after running for the first term. However, each time the policy is announced, there is the economist's debate on why core inflation should be targeted as, in the last year or so, it has run lower than headline inflation. The reason is that, last year, food inflation was high, which increased headline inflation while core inflation was relatively low. An ideological issue is whether policy should narrowly focus on core inflation, which is theoretically what can be targeted by monetary policy. The logic here is that food prices cannot be influenced by policy. There can be no argument here as prices of pulses or cereals are not dependent on interest rates but supplies. Therefore, core inflation makes more sense. Or so goes the argument.

The argument here is that monetary policy deals with the entire economy and not just the 'core inflation' sectors. Policy is to impact inflationary expectations and adjust the real interest rate accordingly. After all, the rate influences not just lending but also savings and, hence, cannot ignore the broader macros. Therefore, the headline inflation number should be under focus.