Inflation target below 6% may cost growth: RBI study
Synopsis
According to the study, India’s threshold consumer inflation — a level beyond which price rise hurts growth — is 6%. Currently, the flexible inflation target is 4% that can move 2 percentage points either way.
By ET Bureau
Mumbai: India risks sacrificing economic growth and exposes itself to the need for constant policy interventions if it targets an inflation rate below 6% — the threshold inflation level, hints a study headed by a former member of the Reserve Bank of India’s Monetary Policy Committee.
If the country then chooses an inflation target that is lower than the threshold level, it cannot achieve its potential output growth and the system would remain in long-run disequilibrium requiring constant policy interventions to stabilise,” says a paper by the Development Research Group, an RBI-backed independent research initiative.
According to the study, India’s threshold consumer inflation — a level beyond which price rise hurts growth — is 6%. Currently, the flexible inflation target is 4% that can move 2 percentage points either way.
The research led by Ravindra Dholakia, the former MPC member with a dovish view, comes soon after the government reiterated the same level of inflation target despite strong arguments to raise
“The findings of the present study caution the policymakers not to ignore the probable cost of lower inflation in terms of lower longterm growth of output and employment and a hence lower rate of the poverty reduction,” it said. “These costs and benefits of fixing a long-term inflation target will have to be considered while making the choice.”
But the findings of the study also show that the threshold inflation and corresponding growth depends on the other two parameters — the ratio of fiscal deficit to GDP and current account deficit to GDP.
The study estimates the trade-off between long-run inflation and steady-state growth rate. The gain in growth would be 15 basis points for a 100 bps reduction in inflation towards the threshold level. A 100 bps reduction in inflation from the threshold could result in a 40 bps loss in growth. “Even in the latter case, it would take more than two decades to recover the cost of sacrificing GDP to bring down the equilibrium rate of inflation,” it said.
If the country then chooses an inflation target that is lower than the threshold level, it cannot achieve its potential output growth and the system would remain in long-run disequilibrium requiring constant policy interventions to stabilise,” says a paper by the Development Research Group, an RBI-backed independent research initiative.
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According to the study, India’s threshold consumer inflation — a level beyond which price rise hurts growth — is 6%. Currently, the flexible inflation target is 4% that can move 2 percentage points either way.
The research led by Ravindra Dholakia, the former MPC member with a dovish view, comes soon after the government reiterated the same level of inflation target despite strong arguments to raise
“The findings of the present study caution the policymakers not to ignore the probable cost of lower inflation in terms of lower longterm growth of output and employment and a hence lower rate of the poverty reduction,” it said. “These costs and benefits of fixing a long-term inflation target will have to be considered while making the choice.”
But the findings of the study also show that the threshold inflation and corresponding growth depends on the other two parameters — the ratio of fiscal deficit to GDP and current account deficit to GDP.
The study estimates the trade-off between long-run inflation and steady-state growth rate. The gain in growth would be 15 basis points for a 100 bps reduction in inflation towards the threshold level. A 100 bps reduction in inflation from the threshold could result in a 40 bps loss in growth. “Even in the latter case, it would take more than two decades to recover the cost of sacrificing GDP to bring down the equilibrium rate of inflation,” it said.
India's threshold inflation level is 6 per cent: Fromer MPC member
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Synopsis
The research paper is significant as the Reserve Bank adopted flexible inflation targeting framework as a formal monetary policy objective since 2016, under which price stability is the prime goal of monetary policy and the government sets an infl...
India's inflation levels may be needed to be managed at its higher end of the target band to achieve its potential growth. The threshold inflation level for India is 6 per cent according to a research paper authored by former monetary policy committee (MPC) member Ravindra Dholakia and a team of RBI economists.
" Threshold inflation for India at around 6 per cent" say a research paper by former Monetary Policy Committee member Ravindra H. Dholakia and a team of economists Jai Chander, Ipsita Padhi and Bhanu Pratap. " An inflation target that is lower than the threshold level, cannot achieve its potential output growth and the system would remain in long-run disequilibrium requiring constant policy interventions to stabilize" the study concludes.
The research paper is significant as the Reserve Bank adopted flexible inflation targeting framework as a formal monetary policy objective since 2016, under which price stability is the prime goal of monetary policy and the government sets an inflation target for the central bank. The current target is set at 4 per cent which can range in a band of 2 per cent either ways, which was set in April when the new MPC term started. The inflation targeting framework came for criticism from various quarters as CPI inflation crossed 6 per cent , beyond the upper end of the band for several months in FY'21 due to the restrictions caused by the pandemic induced nation-wide lockdown
But the findings of the study also show that the threshold inflation and corresponding growth depends on the other two parameters – the ratio of fiscal deficit to GDP and Current account deficit to GDP.
The concept of threshold inflation is linked to the level of inflation beyond which it becomes detrimental to economic growth.
The study has made estimates of the trade-off between long run inflation and steady state growth rate. A 100 bps ( one bps is 0.01 per cent) reduction in inflation from the threshold level could result in 40 bps loss in growth and 15bps of gain in the growth for 100bps reduction in inflation towards the threshold level.
Policymakers may choose to set the inflation target below the threshold level only after considering the costs of sacrificing growth and implied poverty alleviation rate with likely benefits in terms of the distributional and financial stability implications which are not examined in this study, the paper said.
" Threshold inflation for India at around 6 per cent" say a research paper by former Monetary Policy Committee member Ravindra H. Dholakia and a team of economists Jai Chander, Ipsita Padhi and Bhanu Pratap. " An inflation target that is lower than the threshold level, cannot achieve its potential output growth and the system would remain in long-run disequilibrium requiring constant policy interventions to stabilize" the study concludes.
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The research paper is significant as the Reserve Bank adopted flexible inflation targeting framework as a formal monetary policy objective since 2016, under which price stability is the prime goal of monetary policy and the government sets an inflation target for the central bank. The current target is set at 4 per cent which can range in a band of 2 per cent either ways, which was set in April when the new MPC term started. The inflation targeting framework came for criticism from various quarters as CPI inflation crossed 6 per cent , beyond the upper end of the band for several months in FY'21 due to the restrictions caused by the pandemic induced nation-wide lockdown
But the findings of the study also show that the threshold inflation and corresponding growth depends on the other two parameters – the ratio of fiscal deficit to GDP and Current account deficit to GDP.
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The concept of threshold inflation is linked to the level of inflation beyond which it becomes detrimental to economic growth.
The study has made estimates of the trade-off between long run inflation and steady state growth rate. A 100 bps ( one bps is 0.01 per cent) reduction in inflation from the threshold level could result in 40 bps loss in growth and 15bps of gain in the growth for 100bps reduction in inflation towards the threshold level.
Policymakers may choose to set the inflation target below the threshold level only after considering the costs of sacrificing growth and implied poverty alleviation rate with likely benefits in terms of the distributional and financial stability implications which are not examined in this study, the paper said.
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