IFC – Is It A Good Framework for Monetary Policy of India?

By Rajiv Kumar, Geetima Das Krishna, and Sakshi Bhardwaj
2 November 2015

Given that the RBI has effectively adopted Flexible Inflation Targeting (FIT), which is also recommended by the IFC, it has become important to ensure that sound institutional arrangements are established to safeguard the process. In this regard it is critical to optimise the composition of the monetary policy committee (MPC) in the RBI and achieve maximum clarity in the rules (Taylor Rule or otherwise) or procedures it will follow to achieve the desired rate of inflation in the economy. However, in doing so, the MPC and the RBI will have to be cognisant of the finding that inflation is correlated with food prices, which in turn are directly linked to the administered prices announced by the government. Therefore, it would be hugely costly for the economy in terms of potential loss of output and employment, if the RBI was exclusively responsible for keeping inflation within the targeted range. The government of India and RBI must work in tandem to ensure macro stability in the coming period.

This paper is divided in the following sections: Section I gives a brief summary of Flexible Inflation Targeting policy recommendations in India. Section II includes the literature review of Inflation Targeting. Section III looks at the trend of Policy Interest rate, Taylor rule rate and Inflation in India. Section IV analyses the relation between food and core inflation. Section V examines the trade-off between the real interest rate and investment growth. Section VI concludes the paper.