Does inflation targeting work in India?, Pg8

Key Highlights:

• India has completed a decade of Inflation Targeting (IT) as a formal policy framework of the Reserve Bank of India (RBI).
• Under this framework, the RBI aims to contain inflation at 4% within a band of (+/-) 2 percentage points.
• The article argues that IT may not be effective in India due to a flat New Keynesian Phillips Curve (NKPC).
• Public inflation expectations in India are consistently higher than the RBI's projections.

Inflation Targeting.jpg

Detailed Insights:

• The RBI attempts to control inflation by adjusting the repo rate to manage demand and by influencing public inflationary expectations.
• The New Keynesian Phillips Curve (NKPC) theoretically describes a relationship where rising output leads to increased inflation.
• The article's academic work suggests India's NKPC is flat, implying no significant trade-off between output and inflation.
• A flat NKPC is attributed to the lack of bargaining power among a large majority of Indian workers (around 92%).
• If the NKPC is flat and expectations are not anchored, IT could lead to lower output without effectively controlling inflation.
• Indian household inflation expectations, surveyed by the RBI, consistently exceed the RBI's own projections by a significant margin.

Key Concepts Involved:

• Inflation Targeting (IT): A monetary policy framework where the central bank sets a specific inflation rate as its primary goal.
• Repo Rate: The interest rate at which the Reserve Bank of India lends money to commercial banks.
• New Keynesian Phillips Curve (NKPC): An economic model illustrating the short-run inverse relationship between the rate of unemployment (or output gap) and the rate of inflation.
• Index of Industrial Production (IIP): An indicator that measures the changes in the volume of production in industrial sectors.