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This newspaper does not believe that, in an interconnected world of large cross-border capital flows and transnational supply chains that can halt production in one part of the world because another part of the world is in disarray, on account of a pandemic or geopolitical tensions, monetary policy’s sole goal can be price stability. Financial stability could become paramount and monetary policy might need to act in tandem with fiscal policy, rather than in glorious autonomy from it. Be that as it may, controlling inflation will remain an important goal of monetary policy. Inflation measured by what index? The Economic Survey says that wholesale prices and core consumer prices (that is, excluding energy and food prices) better correlate with demand than the Consumer Price Index (CPI). Why not target these for inflation control, rather than CPI?
Food and energy have a combined weightage in excess of 50% in the CPI, and inflation in either is driven mainly by supply-side factors, over which monetary policy has little impact. Further, many components of food inflation are transitory and neither call for nor are influenced by monetary policy tweaks. Yet, changes in CPI anchor inflation expectations, given its role as the headline target that guides the monetary policy stance. Weather-induced supply shocks and food’s large weightage in the index can lead to forecast errors, as a recent RBI paper noted. So, the notion that the current inflation targeting framework is biased towards keeping interest rates high is not entirely misplaced. That can cause serious damage to economic growth.
The Survey’s recommendations to update the base year of CPI from 2011-12 and to incorporate price data from modern ecommerce make eminent sense.
This piece appeared as an editorial opinion in the print edition of The Economic Times.