The RBI recently floated a discussion for suggestions from all stakeholders to devise an optimal inflation policy rule for the future, under its review of the Monetary Policy (MP) due in March 2026. The RBI shifted to the Flexible Inflation Targeting (FIT) rule in June 2016, with a Consumer Price Index (CPI) inflation target of four per cent and a tolerance band of 2-6 per cent. Following global practices of central banks of many countries following inflation targeting (IT) and seeking public consultations, the RBI also opened discussion on the nuances of the future course of MP, including whether to switch to Consumer Price Index (CPI) core or continue with headline inflation (which encompasses fuel and food prices), to revise the inflation target and range values, or to completely replace the target value with a range, given the rising global economic shocks and inflation vulnerability.
Many theorists doubt the viability of MP in controlling inflation, as in India, inflation is mostly driven by supply shocks like food, fuel, weather, and global prices, which MP tools cannot control directly. There are also discussions on prioritising growth objectives over inflation, given the disruptions from global uncertainties amid US tariff policies and burgeoning geopolitical tensions.
The recent GST reforms are also targeted at accelerating consumption and investment demand to boost economic growth.
Proponents of inflation control, however, contend that inflation control policies such as IT promote transparency and credibility of the monetary authority (MA) to anchor inflationary expectations. Investors and households act with greater certainty about the future, empowering long-term stability. Many studies substantiate that inflation has become less volatile with the adoption of IT, with the average inflation being lower in the post-IT regime.
With the growth vs. inflation debate gaining momentum, the MA cannot ignore the pressure on the economy to perform better. At the same time, it cannot undermine the importance of inflation control in the medium run, which, if compromised, can disturb economic stability. The MA therefore has to balance between the need for an expansionary policy in the short run and one that can also help the economy to stand firmly in the medium run.
The MP should continue with the target of 4 per cent inflation with a few relaxations to accommodate the hostile global economic scenario. In the short run, due to high volatilities, it is difficult to remain committed to a specific target.
The RBI may therefore think of simply following a range of 2-6 per cent or increasing the band slightly, to 2.5 per cent as the upper limit. Once the winds settle, it can reverse to the range of ±2 per cent around the target value. This will help to mitigate external uncertainties without compromising the growth objective and also allow policymakers to avoid responding every time to economic disruptions.
Domestically, the introduction of large-scale GST reforms, introduced to vitalise demand and economic activity, is also expected to result in an escalation of inflationary pressures in the near future. It further underscores the need for a balance between expansionary short-term policies and a stable long-term MP. Additionally, the RBI should continue to focus on the headline inflation instead of chasing the core, as it curbs speculative reactions from the general public and facilitates a stable economic framework. Given the aggressive and uncertain global economic discourse, an optimal MP framework would be one that caters to stabilising inflation in the medium run, and also allows the economy sufficient support to face the challenges and perform well.
The writer is assistant professor at Sri Guru Gobind Singh College of Commerce, University of Delhi
