Should RBI resort to Inflation targeting? targeting?

(AGAINST THE TOPIC) Shayak Kumar Sahu (119278007) Ashish Mundawane (119278113)

Shailesh J Mehta School of Management, IIT Bombay



Ben Bernanke and his advisor Mishkin ‡ An economic policy in which a central bank estimates and projects an inflation rate and then attempts to steer actual inflation towards the target ‡ Controls the set target using interest rate changes and other monetary tools Shailesh J Mehta School of Management.What is inflation targeting ? ‡ Developed by Federal Bank chairman Mr. IIT Bombay 3 .

IIT Bombay 4 .K. Shailesh J Mehta School of Management. including those in :‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Australia Canada Finland Israel New Zealand Spain Sweden and U.Countries following Explicit Inflation Targeting Explicit inflation targeting has been adopted by a number of central banks around the world.

bank raises interest rates to stabilize and ´vice-versa ´ ‡ Central bank raising or lowering interest rates become more transparent under this policy Shailesh J Mehta School of Management. IIT Bombay 5 .Trade-off between interest rates and the inflation rate ‡ Interest rate and inflation rate are inversely proportional ‡ For example if inflation is above the target.

‡ If inflation gets too low. the bank would lower rates to juice up growth. raising inflation. ‡ If inflation is getting above the target. Shailesh J Mehta School of Management. ‡ It steers monetary policy to try to hit the target inflation rate.What actually happens? ‡ In inflation targeting. the bank would ordinarily raise interest rates to cool the economy and bring inflation back down. IIT Bombay 6 . the bank publicly estimates how high it expects inflation to be in the coming year.

Contd. ‡ Some of the ¶Probable· advantages ² > increased transparency > coherence of policy and > flexibility of the target ‡ Investors know what the central bank considers the target inflation rate to be. IIT Bombay 7 . therefore may more easily factor in likely interest rate changes in their investment choices ‡ Hence it supposedly brings transparency and predictability to the markets Shailesh J Mehta School of Management.

‡ Moreover. IIT Bombay 8 .Factors which conflict the Inflation targeting policy ‡ For emerging markets the real interest rate (r*) leads to conflict with inflation targeting. structural changes which plays a part in changing the expected inflation rate.There is often no political consensus that low inflation should be the overriding objective of monetary policy. Shailesh J Mehta School of Management. ‡ There is always a trade-off between reducing inflation and unemployment. ‡ Fiscal dominance . there are short run shocks such as oil shock.

‡ Inflation targeting would give the Fed too little flexibility to stabilize growth in the event of an external economic shock. it would not enhance overall accountability or transparency given the multiple objectives of monetary policy ‡ Prices are always flexible. Price stability cannot be quantified. IIT Bombay 9 . Shailesh J Mehta School of Management. substitution. shift in product quality. there is always a margin of error as well as upward bias while measuring the inflation due to new products. even without imposing a rigid rule.Counter arguments against Inflation Targeting ‡ Inflation targeting. would unduly reduce the flexibility of the Central Bank to respond to new economic developments in an uncertain world ‡ Furthermore. Moreover. etc.

that is.) ‡ There is always a trade-off between reducing the inflation rate and achieving other goals such ad maximizing GDP growth. employment and exchange rates. ‡ There are multiplicities of excuses for missing the targets and always there are variations around the target point. optimal employment and financial stability ‡ Giving more importance to curbing the inflation to more extent. ‡ An explicit target might turn central bankers into "inflation nutters".Counter argument (Contd. can hamper other economic factors. IIT Bombay 10 . central bankers who concentrate on the inflation target . Shailesh J Mehta School of the extent of detriment of stable growth.

Counter argument (Contd.) ‡ Outside Lag .Inflation targeting might fail to be operational because of the time that it takes monetary policy actions to affect inflation. Shailesh J Mehta School of Management. ‡ Just as uncertainty about future inflation impedes good economic decision making. so does uncertainty about the future level of output and employment. IIT Bombay 11 . ‡ inflation targeting highlights the inflation objective of central banks but tends to obscure the other goals of policy. as well as the difficulties of forecasting inflation.

IIT Bombay 12 .Some Latest Trends Over Inflation Targeting Shailesh J Mehta School of Management.

1 had inflation below target and 7 reported inflation within the target range. IIT Bombay 13 .> The following report mentions the inflation of various countries where central bank has opted for Inflation targeting. 24 reported to have inflation above target. Shailesh J Mehta School of Management. > Out of 32 countries.

Shailesh J Mehta School of Management. IIT Bombay 14 .

Of the 32 countries.The chart below shows the change in inflation versus target for the countries which opted for inflation targeting. 23 countries had inflation go above target. Shailesh J Mehta School of Management. 4 countries had inflation falling closer to target while 5 were staying within target. IIT Bombay 15 .

IIT Bombay 16 . interest rates and unemployment.Conclusion ‡ These reports shows that most of the countries saw inflation increasing compared to the target. ‡ The change in prices can change the inflation rate which is targeted. reserve bank and government should take necessary measures to increase or decrease inflation keeping in view the other factors Shailesh J Mehta School of Management. ‡ So instead of fixing a specific value of inflation. it could have detrimental effect on stable growth and exchange rates. ‡ Along with that. ‡ There is little flexibility in tackling other issues like economic shock.

investmentpostcards.References ‡ http://wwwsiepr.pdf ‡ Shailesh J Mehta School of IIT Bombay 17 .edu/yftp/Targeting/TargetingFiscalPaper. pdf ‡ http://www.

IIT Bombay 18 .THANK YOU Shailesh J Mehta School of Management.

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