Day 12 – Q 3.What is ‘inflation targeting’? Discuss the tools that are used for inflation targeting. How effective have they been in India? Discuss.
3. What is ‘inflation targeting’? Discuss the tools that are used for inflation targeting. How effective have they been in India? Discuss.
मुद्रास्फीति लक्ष्यीकरण ’क्या है? उन उपकरणों पर चर्चा करें जिनका उपयोग मुद्रास्फीति लक्ष्यीकरण के लिए किया जाता है। वे भारत में कितने प्रभावी रहे हैं? चर्चा करें।
Inflation targeting is a monetary policy strategy used by Central Banks for maintaining price level at a certain level or within a range. It indicates the primacy of price stability as the key objective of monetary policy.
- The argument for price stability stems from the fact that rising prices create uncertainties in decision making, adversely affecting savings and encouraging speculative investments.
- Inflation targeting brings in more predictability and transparency in deciding monetary policy.
- If the central banks could ensure price stability, households and companies can plan ahead, negotiating wages on the basis of expecting low and stable inflation.
- Various advanced economies including United States, Canada and Australia have been using inflation targeting as a strategy in their monetary policy framework.
India adopted inflation targeting based on Urjit Patel Committee Report. Under this RBI would aim to contain consumer price inflation within 4 percent with a band of (+/-) 2 percent.
Tools for inflation targeting:
- Liquidity Adjustment Facility- With this RBI controls the money supply in the economy. These interest rates and inflation rates tend to move in opposite directions.
- Open Market Operations- RBI buys or sells short-term securities in the open market, thus impacting money available with the public.
- Variable Reserve Requirement- Cash Reserve Ratio (CLR) and the Statutory Liquidity Ratio (SLR) are increased or decreased in accordance with inflation or deflation respectively.
- Bank rate- It is the rate at which RBI lends money to commercial banks without any security. When bank rate is increased interest rate also increases leading to inflation.
- Moral Suasion- If there is a need RBI can urge the banks to exercise credit control at times to maintain the balance of funds in the market.
The tools of inflation targeting have been effective
- Inflation contained- For the last year, inflation remained in the desired bracket of 4%, giving good real returns to the people.
- Impact on growth- Though inflation was within limits, but the growth could not be spurred because of the mandate of RBI to stay within the target.
- Better prediction and stability- With each monetary policy review, RBI provides a ‘neutral’, ‘accommodative’, or ‘calibrated tightening’ stance giving an indication to businesses and banks about the trends in future interest rates.
Inflation targeting thus had tremendous success in controlling inflation through monetary policy. However, growth suffered due to this, thus its advisable to not look at just one indicator, rather at multiple indicators and making financial stability as the underlying theme.