MPC external members should be appointed full-time, says Chetan Ghate

Ghate says flexible inflation targeting has established a credible nominal anchor, while stronger monetary-fiscal coordination remains important for managing inflation

Q&Chetan Ghate, former external member, Monetary Policy Committee (MPC), and professor of economics at the Indian Statistical Institute (ISI), Delhi, says inflation management has improved tremendously with the flexible inflation framework, but there are challenges. Ghate, in an email interview to Manojit Saha, says inflation targeting requires strong monetary-fiscal coordination, which has also improved. Edited excerpts: 

How has the inflation-targeting regime with headline consumer price index (CPI) inflation as the target and the six-member MPC equally divided between external and internal members, fared since it came into effect 10 years ago? 

As I mentioned in last year’s Business Standard Summit in Mumbai, inflation targeting has worked well in India. 

Flexible inflation targeting (FIT) has established a credible nominal anchor; financial markets understand the objective of the MPC better; FIT has led to a credibility premium; and the RBI communication and forward guidance (through the stance) has sharpened over the years. Inflation has tumbled from the high inflation years of 2010-2013. Based on the 2024 series going back, during 2016-2020, the first MPC average inflation was 4.3 per cent (October 2016 to September 2020). During 2020-2024, the second MPC, average inflation was 5.7 per cent (October 2020 to September 2024). During October 2024–August 2026, average inflation was 3.2 per cent. Overall, inflation management has improved tremendously. However, this is not to say there aren’t challenges. Sizeable fiscal deficits can contribute to demand pressures, which may support growth but lead to over-heating. Inflation targeting requires strong monetary-fiscal coordination, which has also improved. 

The equal division between internal and external members with a casting vote given by the Governor is appropriate. However, the one change I would suggest is that external members in the MPC should be appointed full-time members for the duration of their terms, as at the Bank of England. 

Given the increasing complexity of world economy, this allows independent members to fully devote their time to a complicated task. 

We need to integrate more demand-side labour market indicators into our projections. Right now, we have a variety of supply side labour market indicators through Periodic Labour Force Survey (PLFS) and Consumer Pyramids Household Survey (CPHS). We need to understand labour market slack (like declines in job vacancy postings) better through demand-side indicators and not just the unemployment rate, which is volatile. 

In a recent Reserve Bank of India-Development Research Group (RBI-DRG) study, we show that the size of informality in labour markets matters for monetary policy transmission. Tighter monetary policy creates slack (higher unemployment) in both formal and informal labour markets. Just focusing on the output gap, which is not directly observable, misses the informal-formal dimension.

 

Do you think the 2-6 per cent band is too wide? 

Overall, I think the current band is correct. The band provides some flexibility by targeting inflation over the medium term. Deviations from the target don’t necessarily imply a loss in credibility if inflationary expectations are anchored around the target, which in India’s case is 4 per cent. Successful monetary policy requires a clearly defined mandate emphasising price stability together with a well-defined nominal anchor. 

India’s statutory framework already provides both. One lesson from developing countries is that central banks cannot address all the inefficiencies in the economy, and if other policy makers do not internalise the consequences of their actions, more inefficiencies can occur in the presence of diffused and uncoordinated policy making.

 

Do you think internal members voice similar opinions most of the time? Should they differ more often? 

Sometimes one gets the impression that that there is group-think between internal members of the MPC. There are many reasons for this, but one reason may be that because the RBI has multiple departments working on inflation and growth projections with access to large datasets and multiple research staff, external members tend to give weight to these projections. One requirement could be that independent members make projections on inflation and other variables using their own forecasting models. Some of this is already happening. These can then be compared to the RBI’s projections to get a holistic view on the economy and provides a more diverse perspective on outcomes.

 

Do you think volatile food inflation impacts the efficiency of an inflation targeting framework? 

Food inflation impacts the efficiency of an inflation targeting framework. Food inflation can be caused by adverse supply side shocks (e.g., poor rainfall), or public interventions in the food sector that are in the form of a demand shock (agriculture procurement). In a large body of work with co-authors which was inspired by my time on the MPC, we show that if monetary policy is not sufficiently tight in response to inflationary shocks from the agriculture sector, these shocks can impose large welfare costs. 

Households can enjoy higher consumption levels in the absence of these shocks and these differences are large if monetary policy is not tight. So, RBI’s monetary policy needs to pay careful attention to fiscal interventions in the agriculture sector The size of the agriculture sector also impedes the effectiveness of monetary policy transmission. The terms of trade between agriculture and manufacturing matters for the transmission of monetary policy, and needs to be taken into account.

 

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

We can think of core inflation as the RBI’s best read for underlying demand-side inflation. My co-authors and I have a recent working paper on forecasting core inflation (CAMA WP 2026). We find that a simple forecasting model that forecasts the central path of core inflation is very hard to beat compared to a large slew of fancier models that use multiple indicators. 

The indicator panel does improve the risk assessment though, or what economists call the tail of the distribution, which the RBI brings out through its fan charts and balance of risks in the monetary policy report. 

This work will provide a guide to the RBI on where to spend modelling effort, and how to frame its inflation outlook. It also guards against a common failure in central banks, where adding more indicators feels like adding information, but in practice adds noise.  

And, there is no compelling case for making core the target in India, because what the public understands and trusts is headline inflation.