Inflation Targeting by RBI- Is it effective?

Subject :Economy

Section: Monetary Policy

How inflation is supposed to be controlled by RBI through change in Repo Rate:

Repo rate is the rate at which RBI lends to the banks, the raising of repo reduces inflation through two channels of demand reduction:
- Consumption: Making loans costlier, hence reducing the demand and hence inflation.
- Investment: Costlier credit reduces investment demand, reducing inflation. Further lesser investment is liked to slower creation of jobs that would also contribute to inflation.
This approach sacrifices GDP growth rate for reduced inflation.
From April 2022 RBI has been increasing the repo rate with every MPC meeting. Inflation has also come down during the period. RBI is now expected to pause rate hike.

Criticism of the RBI’s inflation targeting regime:

Ignores the cost-push inflation: The current framework ignores the contribution of indirect taxes to inflation. Thus the fiscal policy tool of managing inflation is ignored and reliance is mainly on increasing interest rates, which reduces growth also.
India’s job-less growth: Reduced investment is supposed to also reduce the demand side inflation by reducing the pace of creation of new jobs. But in India, GDP growth does not come from employment generation. So this channel of inflation control is weak.

What then explains the inflation moderation:

It is suggested that RBI’s policy moves just happen to be in sync with the actual inflation reduction which is explained by factors like: reduced crude oil prices and better agricultural output over the last year.
International raising of interest rates has helped reduce crude oil prices, but RBI’s role may not be relevant here, and may just be a free rider here.