The wrong target

Feb 04 2014, 03:30 IST
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SummaryIndia shouldn’t be too hasty in adopting inflation-targeting, junking the time-tested multiple indicators approach

RBI recently released the Report of the Expert Committee, chaired by deputy governor Urjit Patel, to revise and strengthen the monetary policy framework. As was expected from the terms of reference and the composition, it was clear ab initio that in line with the recommendations of the Mistry Committee (2007) and Rajan Committee (2009), India would soon have an inflation target of its own, to join the elite club of central banks like that of the UK, irrespective of the fact that advanced economic systems, with seamlessly integrated financial markets, only adopted inflation-targeting just about a decade ago. Our financial markets and institutions will at least take a decade, if not more, to reach that level of maturity, depth and integration.

First, it is fascinating to know that a central bank of a country, self-motivated, is seeking accountability for its actions. This is indeed rare, commendable and should be appreciated by the policymakers across the country. The Patel Committee report is a well-compiled document but deeper examination reveals that the review of literature is generally based on articles published before 2008. The reason is that since the global crisis, a few articles advocate inflation-targeting, a fact acknowledged in the report itself. Most of the countries adopted inflation-targeting before 2003. In addition to India, the following G20 countries do not have such a regime: Argentina, China, France, Germany, Italy, Japan, Russia, Saudi Arabia and the US, though many of them have well-developed financial markets. Hence, the hurry in implementing inflation-targeting in India is intriguing, given the last monetary policy announcement.

In sharp contrast, Bank of England (BoE) Governor Mark Carney observed in his speech on January 24 at the Davos summit: “We wouldn’t even begin to think about raising interest rates until the unemployment rate fell to 7%,” doubtlessly not the conservative central banker Kenneth Rogoff wrote about (1985) but a prudent one for difficult times. A day earlier, Paul Fisher, executive director, BoE, had argued at great length as to why the UK central bank’s monetary policy committee did not tighten the policy to rein in inflation. He observed that tightening would have depressed the economy further by consciously pushing down output and employment. To quote: “So, despite the costs of the inflation which were experienced, the costs of the policy needed to counteract it would have been even greater in this specific circumstance of one-off shocks and left the UK economy

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