Inflation-Targeting Framework in India
In 2016, India formally adopted the inflation-targeting framework, fundamentally changing its monetary policy approach. Prior to this, the Reserve Bank of India (RBI) had multiple goals, which led to a diffused focus on controlling inflation. The new framework focused on a single mandate: maintaining a consumer price index (CPI) inflation rate of 4%, with a 2% margin.
Advantages and Evidence of Success
- The framework resulted in a significant decrease in inflation rates, with average CPI inflation post-2015 being about half of what it was in the previous decade.
- Despite initial reductions in inflation possibly due to external favorable factors, stability was maintained during global price increases between 2022 and 2024.
- This stability suggests a build-up of policy credibility, which is a cornerstone of any successful inflation-targeting regime.
Importance of Credibility
Credibility is crucial for maintaining stable inflation expectations. When the public trusts the RBI, temporary shocks do not escalate into long-term inflation expectations. This phenomenon creates a virtuous cycle where credibility leads to stable expectations and, consequently, low inflation.
- Surveys indicate that while people still expect inflation higher than the 4% target, their expectations are less volatile.
- Research shows that households’ and professional forecasters’ inflation expectations are becoming more anchored and stable.
Potential Improvements
While the framework should not undergo major changes, enhancements can be made in data collection and transparency:
- Upgrade Surveys: The RBI's survey of household inflation expectations should be expanded to include long-term expectations for better policy insights.
- Business Expectations: Systematic data on firms’ inflation expectations is lacking. The RBI should regularly survey firms to understand their views on future inflation, aiding in more effective policy responses.
Future Challenges and Recommendations
Given potential future challenges like climate-related supply shocks and volatile energy prices, it is essential to preserve and strengthen the RBI’s credibility rather than revising the framework and risking a loss of trust in monetary policy.
Disclaimer: The opinions expressed are personal views of the authors and do not reflect those of the Federal Reserve Bank of Boston or its affiliates.