Opinion
Should RBI target core inflation instead of retail? Perish the thought.
Summary
- Inflation targeting is a bigger challenge in India than in America, say, where monetary policy is sensitive to its jobs market, but while India’s economic conditions admittedly differ, taking an easier approach would be a cop-out. We need real price stability.
Inflation targeting works reasonably well in America, but does India need a modified version of it? After all, what drives price instability here differs.
It’s why members of the Reserve Bank of India’s (RBI) panel for monetary policy are unlikely to take note of a Mint+Shine study for the first quarter of 2024-25 that found 95% of all employees in a formal-sector sample on the lookout for a job change, which could suggest a round of salary bargaining.
Sure, the government has its own periodic labour force survey, which tracks jobs in every sector of the economy, but even that’s only a by-the-way input for RBI’s interest-rate policy.
Unlike in the US, whose central bank has worked hard to smother its 2022 inflation flare-up with rate hikes and is now watching the labour market closely as it nears its 2% target, inflationary impulses in India tend to arise chiefly from erratic farm supplies. Indeed, commodity data is what Indian policymakers must pore over. This is a significant difference.
Also read: Why food inflation cannot be excluded from target inflation
Apart from price stability, America’s Federal Reserve, its central bank, also has a mandate to maximize employment. As seen in developed economies, the two are linked. If its labour market tightens, implying rivalry among recruiters, wages get bid upwards and feed inflation.
If payroll additions slacken, as is the case right now, then job seekers vying for jobs make it easier to keep a lid on overall price levels too. A mostly formal economy means the US has the luxury of reliable data to plot its trade-off between jobs and prices on a graph.
This ‘Phillips curve’ was shifting its shape even before pandemic supply squeezes and relief money—coupled with geopolitical flux—warped American prices, making it harder to identify a level of employment that’s consistent with stable inflation.
Today, as US joblessness rises and fresh hiring flags amid softening prices and recession fears, expectations have risen of a rate cut by the Fed. A sudden sense among investors that it might have held rates high for too long may even have rattled stock markets in early trading this week.
In contrast, job conditions in India have no real bearing on retail inflation, which RBI must reduce to 4% but often tracks agricultural output, oil import costs and other readings riddled with exasperating uncertainty. This being so, targeting inflation stripped of volatile fuel and food prices (to its ‘core’, i.e.) would surely ease RBI’s job.
Also read: Rate moves unlikely; time for RBI to step up liquidity support
While the idea of such a target switch is tempting, it is also inadvisable. Price stability in general is what policy must aim for, after all, so that what the rupee is worth declines along a predictable path of purchasing power. This cannot be assured by trying to pin down a half-measure. Instead, it risks letting the prices of essentials off the hook.
This would hurt the poor more than others, of course. But a currency whose real value is unstable where it counts, out in the market, also has another bad effect. It unfairly favours borrowers over lenders (and savers), since inflation reduces the real burden of debt over time, unless loans are kept costly to compensate.
Given the structural asymmetry in power between a debt-laden government (and businesses) on one side and ordinary folks (and banks) on the other, a central bank empowered to keep actual inflation in check is worth having.
Good governance by the Centre involves not just backing an RBI looking to quell unruly prices, but also exercising fiscal restraint, so that state spending doesn’t send excess money sloshing around the economy. All said, we should stick to our retail target. Going after core inflation alone would be a cop-out.
