The Reserve Bank of India (RBI) working paper by Harendra Kumar Behera and RBI deputy governor Michael Debabrata Patra on inflation targeting has waded right into one of the world’s most vibrant policy debates, one between inflation hawks and dis-inflationists. The former believe that easy-money policies pursued after the West’s financial crisis of 2008-09 that have given way to printing money as a path out of the covid crunch will eventually lead to much higher rates of inflation than experienced by the developed world in the last three decades. On the other side are dis-inflationists who believe that the world has undergone a structural change—thanks to demography, technology and globalization—that has caused the ‘Phillips Curve’ to flatten in some economies. By this, they mean that a long-observed trade-off between growth and inflation, under which an accelerative economy would overheat after a ‘speed limit’, has lost its disruptive power. The US Federal Reserve has recently loosened its rules a bit on fighting inflation, but there is no reason for RBI to follow suit.
In their paper, Patra and Behera set out to identify an appropriate inflation target for India, and find that it is still 4%, the central aim of an explicit policy adopted by RBI in 2016 that is due for a review in March. “If it ain’t broke,” they argue, “don’t fix it.” Yes. Take the pre-pandemic record. Retail inflation was in the range of 4.2% from 2014 to 2019, less than half the average over 2007-14. If India’s steady decline in inflation is consistent with a flattening of the Phillips Curve, the paper asks, what must be the right target at this point in time? A target set lower than the trend rate will result in an ‘overkill’ of tighter money that would hurt the economy, say the authors, while a higher aim will expose it to inflationary shocks. It would be best then to target 4%, as before, with elbow room of plus or minus 2 percentage points to give policymakers some flexibility.