INFLATION IN MONETARY POLICY

Subject: Economics

Concept:

• Monetary Policy Committee opined that inflation was likely to remain elevated, “barring transient relief in the winter months from prices of perishables”. This, it stressed, “constrains monetary policy at the current juncture from using the space available to act in support of growth”.

Projection on CPI inflation

• Consumer Price Index (CPI) inflation, the RBI said, would average 6.8% for Q3 and 5.8% in Q4 — both levels above or close to the 6% upper bound of the target range for ensuring price stability — before easing to a 5.2% to 4.6% range in the first half of the next financial year, starting April 2021.

How does India measure retail inflation?

• Inflation is the rate of change in the prices of a given set of items. India bases its retail inflation metrics on the Consumer Price Index (CPI).
• The index records changes in prices for a sample of family budget items that are representative of what consumers typically spend their household income on — food, fuel, housing, clothing, health, education, amusement and even paan, tobacco and intoxicants. The measure is based on a weighted average.
• The CPI-based retail inflation is measured monthly and is published as a percentage value of change in the index from the corresponding year-earlier period.
• Data for a certain month are released by the Ministry of Statistics and Programme Implementation generally on the twelfth day of the subsequent month.

Why is faster inflation a concern for policymakers?

• Faster retail inflation is indicative of prices of household items rising quickly. While inflation affects everyone, it is often referred to as a ‘tax on the poor’ as the low-income stratum of society bears the brunt.
• Persistent high inflation pushes several items out of reach for this category of consumers. For example, onions and potatoes are generally a key staple in an average Indian family’s diet. But, if the price of potatoes starts rising rapidly, a poor household is often forced to sharply reduce or forgo its consumption of this key source of essential nutrients, including carbohydrates.
• Over time, if unchecked, persistent high inflation erodes the value of money and hurts several other segments of the population, including the elderly living off a fixed pension. It hence ends up undermining a society’s consumptive capacity, and thereby, economic growth itself.

RBI’s role in tackling inflation

• The RBI’s explicit mandate is to conduct monetary policy. “The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth,” the RBI states on its website.
• 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%.

What is core inflation and why is it important?

• Core inflation helps measure inflation after excluding the effects of temporary volatility, especially from prices of items such as fuel and food. For example, seasonal spikes in food prices may skew the inflation rate, but the effect is only transitory.
• Viewing inflation after stripping out such volatility helps give it a better picture of the underlying trend in prices.