The Hindu Business Line : Inflation targeting

INFLATION targeting is fast emerging an useful strategic tool for predictable economic management. The way it is designed to work is for the central bank and the government to arrive at official target ranges of numerically specified inflation rates.

A New Zealand law actually makes it mandatory for the Finance Minister and the Reserve Bank Governor to negotiate and make public a Policy Target Agreement setting out specific inflation targets. It also casts on the Reserve Bank the statutory responsibility "to formulate and implement monetary policy directed to the economic objectives of achieving and maintaining stability in the general level of prices." Indeed, the Reserve Bank Governor can be sacked, if he fails to achieve the inflation targets.

Though not going so far, a number of industrialised countries, notably, Australia, Canada, Finland, Germany, Israel, Spain, Sweden, Switzerland and the UK, have prescribed variants of inflation targeting in the form of public policy pronouncements. For instance, inflation is to be contained within a standing range of 2 - 3 in Australia, and around two in Finland and Sweden without any time limit. The rates for inflation elsewhere are set within specific time frames: 1 - 3 in Canada over 18 months and 8-11 in Israel over 12 months. Spain and the UK lay down targets with reference to each year and the duration of Parliament. Germany, which has the longest experience with inflation targeting, allows a gradual transition within a time horizon of 12 months from the current level of inflation to a specified steady-state level consistent with price stability.

Although the advantages of keeping inflation within pre-determined bounds are self-evident, the exercise bristles with almost insurmountable complexities. It presupposes all the numerous economic players — producers, consumers, suppliers, business persons, bankers, investors, regulatory agencies and other stakeholders - to mesh to near-perfection their approaches, priorities and decisions and act in unison. It also assumes a credible and dependable methodology in computing the wholesale and consumer price indices with the right weight given to commodities and consumable items. It is this sophisticated understanding and operation of all the economic levers that makes it possible for the central bank to maintain inflation targets within a stated range.

Price stability is ostensibly the sheet anchor of both the Reserve Bank of India and the Government. The inflation level in the recent past has also been low even without any conscious attempt at scientific targeting. It is time the RBI's research and policy planning wing evolved a transparent paradigm for inflation targeting and put it in place after having it approved by State governments also at a specially convened meeting of the Inter-State Council, the Constitutionally authorised mechanism for such purposes.

B. S. Raghavan

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