Inflation Targating
Understanding inflation targeting
I
C. Rangarajan
nflation targeting is back in the news and this is welcome. I have always held the view that the dominant objective of monetary policy is the maintenance of price stability. Inflation targeting gives precision to the concept of price stability.
In any monetary policy framework, a key ingredient is an enunciation of its objectives.
This aspect has assumed increased significance in the context of the stress being laid on the autonomy of central banks. Autonomy goes with accountability, and accountability in turn requires a clear statement of goals.
The case of price stability as the major objective of economic policy rests on the assumption that volatility in prices creates uncertainties in decision-making. Rising prices adversely affect savings while making speculative investments more attractive. These apart, there is a crucial social dimension, particularly in developing countries. Inflation adversely affects those who have no hedges against it, and this includes all poorer sections of the community. This is indeed a very strong argument in favour of the maintenance of price stability in emerging economies.
Price stability and growth
A crucial question that arises in this context is whether the pursuit of the objective of price stability by monetary authorities undermines the ability of the economy to attain other objectives such as growth. In short, the question is whether there is a trade-off between inflation and growth. There is a general consensus that over the medium and the long term, there is no such trade-off and an environment of low inflation is most conducive to faster economic growth. However, there could be such a possibility in the short term. By injecting greater demand and thereby generating higher inflation, higher growth may be achieved. However, to sustain this growth, the authorities may have to generate higher and higher inflation. This will end up as a selfdefeating exercise.
What then is the
I
C. Rangarajan
nflation targeting is back in the news and this is welcome. I have always held the view that the dominant objective of monetary policy is the maintenance of price stability. Inflation targeting gives precision to the concept of price stability.
In any monetary policy framework, a key ingredient is an enunciation of its objectives.
This aspect has assumed increased significance in the context of the stress being laid on the autonomy of central banks. Autonomy goes with accountability, and accountability in turn requires a clear statement of goals.
The case of price stability as the major objective of economic policy rests on the assumption that volatility in prices creates uncertainties in decision-making. Rising prices adversely affect savings while making speculative investments more attractive. These apart, there is a crucial social dimension, particularly in developing countries. Inflation adversely affects those who have no hedges against it, and this includes all poorer sections of the community. This is indeed a very strong argument in favour of the maintenance of price stability in emerging economies.
Price stability and growth
A crucial question that arises in this context is whether the pursuit of the objective of price stability by monetary authorities undermines the ability of the economy to attain other objectives such as growth. In short, the question is whether there is a trade-off between inflation and growth. There is a general consensus that over the medium and the long term, there is no such trade-off and an environment of low inflation is most conducive to faster economic growth. However, there could be such a possibility in the short term. By injecting greater demand and thereby generating higher inflation, higher growth may be achieved. However, to sustain this growth, the authorities may have to generate higher and higher inflation. This will end up as a selfdefeating exercise.
What then is the