We are all inflation-targeters now, at least since RBI published the Urjit Patel committee report on strengthening the monetary policy framework in India. Inflation, at over 10% annually for the last six years, is something that definitely needs fixing. But is inflation-targeting (IT) the right formula?
In order to understand that important question, one needs to know the determinants of inflation. The US gave up on the notion that the growth of money supply determines inflation sometime in late-1983, when it stopped reporting the eagerly watched money supply numbers on Thursday afternoons. At that time, US CPI inflation had already come down sharply from its double digit peak of 13.5% in 1980 to around 3%. After the peak of 5.4% experienced in the Kuwait crisis (oil price) years of 1990-91, US CPI inflation has averaged 2.4%, with a peak of 3.8% in the commodity peak year of 2008 and -0.3% in the commodity trough year of 2009.
Now, the US does not have inflation-targeting as a policy, and may have had a loose, de facto targeting policy in the last decade. But it would be erroneous to conclude that the US experience supports the targeting idea, just as it would be equally erroneous to conclude that all the Q (quantitative easing) liquidities have any impact on US inflation. Whether the Qs have an effect on asset prices remains an open question.
Do other countries’ experiences support the notion that IT has been effective? The Patel report documents that 14 countries adopted IT between 1990 and 2000. The example of inflation in Chile declining from 24% in 1990 to 4.4% in 2007 and in Czech Republic, declining from 10.7% 1998 to 2.9% in 2007 is cited by the report as success stories. India, of course, did not have inflation-targeting but nevertheless CPI inflation did decline from 11.2% in 1990 to 4.4% in 2005 and 6.2% in 2007. The correlation of India’s non-targeted inflation rate with the targeted Chilean and Czech Republic inflation rate is a high 0.73 and 0.66 respectively!
The fact remains that the last six years have witnessed a record high of over-10% CPI inflation rate and RBI is rightly concerned in trying to bring it down by whatever means, even a targeting scheme with a dubious record. There are other suggestions, besides targeting, for bringing down inflation. For example, the IMF argues for a raising of repo rates