RBI’s Inflation Target

Context:

Recently, the Reserve Bank Governor Shaktikanta Das on Thursday emphasised on achieving the four-per cent inflation target for providing the necessary bedrock for sustainable growth.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

1. Monetary Policy Review
2. Understanding Inflation: Definition and Impact
3. Methodology for Assessing Inflation Causes
4. Causes of Inflation in Recent Years in India

Monetary Policy Review

• The Reserve Bank of India’s  Monetary Policy Committee  (MPC) has set the Inflation target at 4% within a band of plus or minus 2 per cent for sustainable economic growth.
• Key facts:
  • Headline inflation moderated to an average of 5.5 per cent during April-December 2023 from 6.7 per cent during 2022-23.
  • However, the food price inflation continued to remain volatile.
  • The deflation in consumer price index (CPI) fuel deepened.
  • Core Inflation moderated to a four-year low of 3.8 per cent in December.
  • As per the data released by the National Statistical Office (NSO), Retail inflation surged to a four-month high of 5.69 per cent in December driven by higher prices of food items such as pulses, spices, fruits and vegetables.

Understanding Inflation: Definition and Impact

Definition of Inflation:

• Inflation, according to the International Monetary Fund, is the rate of increase in prices over a specified period, encompassing a broad measure of overall price increases or specific goods and services.
• It signifies the rising cost of living, indicating the increase in the expense of a set of goods and/or services over a defined period, typically a year.

Impact of Inflation in India:

• In India, the impact of inflation is particularly significant, given economic disparities and a large population.

Causes of Inflation:

• Demand-Pull Inflation:
  • Occurs when the demand for goods and services surpasses their supply.
  • High overall demand in the economy prompts consumers to pay more for available goods and services, resulting in a general price increase.
  • A booming economy with substantial consumer spending can create excess demand, exerting upward pressure on prices.
• Cost-Push Inflation:
  • Driven by an increase in the production costs for goods and services.
  • Factors such as increased incomes, rising costs of raw materials, or disruptions in the supply chain contribute to this type of inflation.
• Built-In or Wage-Price Inflation:
  • Described as a feedback loop between wages and prices.
  • When workers demand higher wages, businesses may raise prices to cover increased labor costs.
  • Collective bargaining by labor unions can lead to higher wages, escalating production costs and subsequently causing higher prices for goods and services.

Methodology for Assessing Inflation Causes

Monthly Shifts in Prices and Quantities:

• Inflation’s nature is determined by unforeseen shifts in prices and quantities within a month.
• Demand-driven inflation occurs when prices and quantities move in the same direction, while supply-driven inflation sees prices and quantities moving in opposite directions.

Supply-Driven Inflation Indicators:

• Unexpected changes in prices and quantities moving in opposite directions indicate supply-driven inflation.
• A decrease in supply linked with a lower volume but increased prices, and vice versa, characterizes supply-driven inflation.

Combining Demand and Supply Factors:

• Assessing overall headline inflation involves combining demand and supply factors at the sub-group level using CPI weights.

Headline Inflation Measurement:

• Headline inflation is a comprehensive measure of total inflation within an economy, encompassing volatile commodities like food and energy.
• Calculated through the Consumer Price Index (CPI), it determines inflation by assessing the cost of purchasing a fixed basket of goods.

Causes of Inflation in Recent Years in India

Impact of Covid-19 Waves:

• Supply disruptions during both Covid-19 waves were the primary contributors to inflation.
• Pandemic-induced lockdowns led to a significant drop in production and demand, causing a sharp decline in economic growth.
• Weakened demand during this phase also led to a reduction in commodity prices.

Reopening Challenges:

• The reopening of the economy, coupled with vaccine distribution and pent-up demand release, resulted in a faster recovery of demand compared to supply.
• This imbalance exerted upward pressure on commodity prices.
• The Russia-Ukraine conflict in 2022 intensified supply chain challenges, compounding commodity price pressures.

-Source: The Hindu, The Indian Express