Central banks have work to do on price stability and inflation targeting

The consumer price index (CPI) has extensive relevance in people's daily lives. Periodic review of CPI composition and weights assigned will keep it robust and relevant

Of late, central banks have received criticism for their handling of price stability and inflation targeting through conduct of monetary policy. The main issue being consumer sentiment not in sync with economic fundamentals. Post-pandemic, high prices and costly borrowings have become a major worry. Prices have gone up of everything that an average household buys. 

 

Academics and economists in advanced economies have given a call to handle the disconnect between post-pandemic inflation statistics and depressed consumer sentiment. Disconnect entailed higher estimated inflation pinch felt by an average family in 5-7 per cent range over official data, namely the consumer price index (CPI). Businesses have shown inflation-linked disproportionate impact and sluggish earnings. Central banks have witnessed inflation-associated signs of delinquencies, retail credit stress, elevated financial system risks and rising inequality. An unhappy trajectory exists. Consumers and employers are disillusioned. Some rediscovery is called for.

 

Real cost of living, a pivotal issue, is not just about food inflation. CPI reflects price change over time for a representative basket of consumer goods and services measuring inflation in day-to-day living costs. Not all household expense items figure in CPI calculation. The expense categories are assigned weights as a percentage of total basket. Central banks use this CPI number as an inflation-targeting tool through monetary policy. CPI has an extensive relevance in our daily life.

 

A substantial audience watches CPI. Decisions about economic activity lean heavily on inflation numbers. An interplay exists between inflation and investment. Inflation is indexed in many contracts including hedging, investments, wages, pensions, insurance and securities. The principle being ‘inflation hedged’. Inflation figures extensively in financial decision making by government, private and even informal sector. Businesses incorporate CPI number as an important component for budgeting and wage hikes.

 

Weights assigned to CPI basket components, especially for services, require periodic revisiting. Lately, disproportionately higher costs of services versus goods have rung alarm bells. An example is medical inflation. Estimates suggest medical inflation grew globally over 14 per cent annually, while CPI grew at 6-8 per cent range. Is medical inflation being driven by aging demographics, high demand, technological advancements, or lack of medical infrastructure, medicines and medical professionals? Central banks may be constrained to handle medical inflation through monetary policy. 

 

Basel-based Bank for International Settlements has suggested periodic review of inflation frameworks. Public resentment and trust erosion can undermine central bank credibility. CPI is not merely a headline number that market trusts. Periodic review of CPI composition and weights assigned will keep it robust and relevant. Occasionally, calls surface for the institution of some judicial mechanism for inflation targeting. Being a policy matter, courts lack jurisdiction. Could international bodies provide some oversight? Some alignment of theory with practical reality is called for.

 

India’s 2025 Economic Survey acknowledges services inflation have remained persistent. India has had a massive jump in young retail stock investors aiming to hedge inflation. The Budget announced tax sops for the inflation-hit middle class. India has taken steps to check substantial variance from national averages on statewide inflation numbers. Tariffs and geopolitical tensions will influence inflation globally. Are there lessons from other central banks? Inflation targeting approaches differ in advanced and emerging economies. The Reserve Bank of India (RBI) has been at the forefront. For RBI, the audience is India and beyond. The global south takes cue from RBI’s approach for strategic, diplomatic and climate aims. Central banks have a task cut out.

 

  The writer is a former senior staff of Asian Development Bank, Philippines. The views expressed are personal. The interview is edited for space and clarity