The genesis of 4% inflation target

Forty years ago, the Chakravarty Committee Report first proposed the aim that the Urjit Patel Committee approved in 2014 shaping inflation targeting in India

- Amol Agrawal

THE RESERVE BANK of India's (RBI) new governor, Sanjay Malhotra, is going to chair his first Monetary Policy Committee meeting on February 5-7. One of the first questions any new governor might ask is, what is the basis of the 4% inflation target? The answer lies in the Chakravarty Committee Report, which incidentally completes 40 years in 2025.

In 1982, then RBI Governor Manmohan Singh instituted a committee under Sukhamoy Chakravarty that submitted its report in 1985. The committee's objective was to review the functioning of the monetary system, keeping the planning era in mind, and assess the interlinkages between monetary policy, fiscal policy, and the banking system.

Before looking at the committee's recommendations, we need to understand the macroeconomic thinking of the times. After the Second World War, Keynesian ideas dominated macroeconomic thinking and policy that paid more attention on increasing growth and lowering unemployment, with inflation on the sidelines. The development of the Phillips curve showed that there was a trade-off between inflation and unemployment, and policymakers could lower inflation easily by allowing a little higher unemployment and vice-versa.