Does ‘inflation targeting’ work in India?
This article examines the effectiveness of the Reserve Bank of India's decade-long inflation targeting policy. It explains the theoretical mechanisms of controlling demand and anchoring public expectations through interest rate adjustments.
Why it matters
Understanding the efficacy of inflation targeting is critical for evaluating the economic stability and monetary policy framework of one of the world's largest emerging markets.
I ndia has just completed a decade of inflation targeting (IT) as a formal policy framework of the Reserve Bank of India (RBI). Under this framework, the RBI is supposed to contain inflation at 4% within a band of (+/-) 2 percentage points. In this piece, we explain the theory behind inflation targeting and test it against the Indian experience.
The RBI seeks to control inflation through two channels: controlling demand and influencing the public’s inflationary expectations. The RBI flexes its policy rate of interest (called the repo rate), which is increased when inflation kicks in. This pushes commercial banks’ lending rates up.
Households become wary of taking home or consumer loans, while businesses postpone decisions to build factories. Demand comes down and, as a result, so does inflation.
Get smarter about the news
Sign up free for a feed built around what you actually care about, Dive Deeper research on any story, and the full text of every article.
Create free accountAlready have an account? Sign in