The Urjit Patel Committee report on monetary policy framework is voluminous and comprehensive with firm theoretical foundations. It puts forth a thought and argues the pros and cons and then takes a call, and hence looks at all aspects of the issue. It cannot be questioned for omission though the reader could have a different view. And, in economics, where several theories exist, stances are not singular.
If one asks whether the approach is monetarist, the answer is ‘yes’ as it targets inflation specifically. Is it Keynesian? The answer is ‘no’ because while it talks of the importance of growth, the focus is still on inflation-targeting. (What happens to India Inc, which is worried about interest rates coming in the way of growth?) Would it come under the rational expectations school? Yes and no. Yes, because it does prefer to give all information in advance though it leaves it to the committee to have the last word to provide the ‘surprise element’ or ‘noise’.
Now, let us look at some points that provoke further thought. Targeting retail inflation, exclusively, in India is debatable. An index based on items which are not usually supported by credit like food, clothing, transport, etc, would not really be affected by policy measures, thus making it less effective. In developed countries, this makes sense as there is little difference between WPI and CPI as the system is efficient. In India, the variation could be between 2-3%. Also, credit cards are widely used to buy all goods which imply that interest rates can affect consumption, which is not the case in India. On the other hand, using CPI inflation to justify high interest rates is all right in the context of real interest rates, but policy can affect at best the WPI components. The report argues that WPI is incomplete and excludes services. But then how many prices of service products are driven by credit flows? The basis of monetary policy is excess demand driving prices a la Irving Fisher. Therefore, ideally, benchmarks should be set for both the inflation concepts.
Related to CPI inflation, targeting 4%± 2 percentage points is quite ambitious. CPI normally reigns higher than WPI which could at the best of times come in this range. By targeting CPI, we run the risk of moving asymptotically towards this mark but never getting there. This will create problems for the Monetary Policy Committee (MPC)