RBI adopted Inflation Targeting as a policy tool for monetary regulation

Inflation Targeting: the new foundation of Monetary Policy Framework

Inflation targeting was in news recently as Union Government and Reserve Bank of India (RBI) on 20 February 2015 signed an agreement on Monetary Policy Framework. As per the agreement, RBI accepted to focus on flexible inflation targeting.

Inflation targeting is defined as an economic policy in which a central bank estimates or decides for a medium-term target inflation rate.

In Indian context, as per the agreement, inflation targeting means that the RBI will have to maintain Consumer Price Index (CPI)-based inflation targets below six per cent by January 2016 and four per cent from 2016-17, with a band of plus/minus two per cent.

The new framework makes RBI more accountable as now it will have to explain to the government if it fails to meet the inflation targets.

The transition from monetary targeting suggested by Chakravarty Committee (1988) to Inflation targeting suggested by Urijit Patel Committee is similar to the practice adopted by central banks in developed countries.

Benefits of Inflation Targeting

The benefits of inflation targeting are many. Two of the prominent benefits of inflation targeting are enhancement of transparency and reduction of price variability.

The most important benefit of inflation targeting is that it helps the central banks to maintain low inflation and low inflation eventually promotes long term growth.

Other most important benefits of using inflation targeting include enhanced public understanding of monetary policy, increased central bank accountability, and an improved state for economic growth.