Another dimension to inflation targeting

Inflation is grabbing attention for being elevated, or fluctuating on account of food prices. The glide path to the target 4% retail inflation rate set for RBI is likely to remain turbulent because of the volatility in food and fuel prices, and in the previous year's base used for monthly comparison. This affects policymaking by increasing the volatility in gilt yields and in exchange rates. The central bank has to - apart from its primary goal of bringing inflation down to its target rate - stabilise the descent to contain turbulence in financial markets. In this, its performance will have to measure up against that of other central banks in securing orderly monetary tightening. The extent of policy rate increases and the pace of their transmission are the key variables.

The jumpiness in inflation numbers is also being mirrored in economic growth that is trending down over the medium term. Seasonal factors like festival demand constitute a large chunk of the recovery in consumption demand. A steadier rise would make it easier for companies to finalise investment decisions, which are also influenced by volatility in interest rates. Apart from the price effect on demand, the income effect can provide a stabilising effect. That calls for a recovery in static real incomes for wage earners. Public investment, despite its higher growth multiplier, has a lagged effect on real wages.

Volatility is to be expected in a monetary policy designed to compress demand when the inflation triggers are on the supply side. An expansionary fiscal stance that does not directly increase disposable incomes reinforces the phenomenon. This adds another dimension to inflation targeting.