Day-21 Answer Writing Challenge : Model Answer

Question: What is Inflation Targeting? What is the framework for inflation targeting in India?  (8 marks, 120 words)

Answer: 

INTRO

• Inflation targeting is a central banking policy that revolves around adjusting monetary policy to achieve a specified annual rate of inflation.
• The inflation target is defined as a medium-term average rather than as a rate (or band of rates) that must be always held.
• 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.

BODY

• Inflation targeting primarily focuses on maintaining price stability but is also believed by its proponents to support economic growth and stability.
• In 2016, the Reserve Bank of India Act, 1934, was amended to provide a statutory basis for the implementation of a flexible inflation-targeting framework, where the Centre and the RBI would review and agree upon a specific inflation target every five years.
• Under this, 4% was set as the Consumer Price Index (CPI) inflation target for the period from August 5, 2016, to March 31, 2021, with the upper tolerance limit of 6% and the lower tolerance limit of 2%.
• MPC being accountable for failure to establish and achieve the nominal anchor.
• The failure defined as the inability to achieve the target of 4 percent (+/- 2 per cent) for 3 successive quarters.
• Such failure requires MPC to issue a public statement & present a report to the government.