'Best practices require publication of RBI letter on inflation target miss'

The flexible inflation target (FIT) framework has “worked very well” and is one of the success stories of the country’s economic reforms, says Jayanth Varma, a former external member of the Monetary Policy Committee and now a Distinguished Professor at the Dhirubhai Ambani University, Gandhinagar. Varma, in an email interview with Manojit Saha, speaks about various monetary policy issues. Edited excerpts: 

 

How do you think the framework — which came into effect 10 years ago with the headline Consumer Price Index (CPI) as the target and a six-member Monetary Policy Committee (MPC) divided equally between external and internal members — has fared?

 

I think that flexible inflation targeting and the monetary policy committee composition have served India very well during the last decade. During a period of severe stress due to the pandemic and geopolitical forces, it has delivered stable inflation and has also anchored inflationary expectations. I would regard it as one of the success stories of economic reform.

 

What changes would you like to propose for both FIT and MPC to strengthen the framework?

 

In my view, the changes required are marginal and incremental in nature, and do not affect the broad framework itself. For example, it would be a good idea to provide research support to the external members of the MPC as is the practice in some other countries. Global best practices would also require publication of the letter that the Reserve Bank of India writes to the government when there is a failure to meet the inflation target.

 

Do you think the current inflation tolerance band has served well, or is there a need to revisit it?

 

In my view, the band is wide enough to account for the fact that monetary policy affects the economy with long lags, and it is difficult to forecast inflation and growth several quarters ahead. At the same time, the band is narrow enough to anchor inflationary expectations. There is, however, a need to develop seasonally adjusted inflation measures that give a better assessment of current inflation.

 

The MPC has started forecasting core inflation. Do you think that it is a step in the right direction? Is there a case for making core the target?

 

A broad measure of consumer price inflation is the correct target for an inflation targeting regime. At the same time, core inflation helps in assessing the persistence of inflationary pressures and the likelihood of second order effects. Because of this predictive power, it makes sense for policymakers to monitor and forecast core inflation without making it a target.

 

The MPC has discontinued voting on the stance as it is not required by law. How important is the stance of the monetary policy in communicating to the market? Do you agree with the discontinuation of voting?

 

I have long argued for abandoning the stance completely. Lack of voting in a sense delegitimises the stance, and would therefore be a step in the right direction.