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What Is Inflation Targeting?

Inflation Targeting:

The Reserve Bank of India (RBI) in its Currency and Finance (RCF) report for the year 2020-21 has said that the current inflation target band (4% +/-2%) is appropriate for the next 5 years.

Inflation Targeting:

  • It is a central banking policy that revolves around adjusting monetary policy to achieve a specified annual rate of inflation.
  • The principle of inflation targeting is based on the belief that long-term economic growth is best achieved by maintaining price stability, and price stability is achieved by controlling inflation.
  • Strict inflation targeting is adopted when the central bank is only concerned about keeping inflation as close to a given inflation target as possible, and nothing else.
  • Flexible inflation targeting is adopted when the central bank is to some extent also concerned about other things, for instance, the stability of interest rates, exchange rates, output, and employment.

Findings of the RCF Report:

  • The trend inflation has fallen from above 9% before FIT to a range of 3.8-4.3 % during the FIT, indicating that 4% is the appropriate level of the inflation target for the country.
  • An inflation rate of 6% is the appropriate upper tolerance limit for the inflation target.
  • On the other hand, a lower bound above 2% can lead to actual inflation frequently dipping below the tolerance band.
  • While, a lower bound below 2% will hamper growth, indicating that an inflation rate of 2% is the appropriate lower tolerance bound.
  • During the FIT period, the monetary transmission has been full and reasonably swift across the money market (trading in very short-term debt instruments) but less than complete in the bond markets.
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