By Yutika Agarwal
In response to the challenges faced as a result of the structural changes in economic activities and financial liberalization, the conduct of monetary policy has witnessed fundamental changes all over the world. To combat the financial crisis and its aftermath, monetary policies in emerging countries require to contend not only with supply shocks but also to manage external shocks emanating from surges and ebbs in capital flows.
India followed the multiple indicator approach which worked fairly well from 1998-99 to 2008-09. The GDP and controlled inflation rate in terms of both WPI and CPI proves the point in case. However, recently, with the co-existence of high inflation and weak growth rate questions have been raised on the efficacy and credibility of this framework. Criticism has followed as a result of using a large panel of indicators as it fails to provide a clear picture and leaves the policy analysts unclear about what the RBI looks at; while making policy decisions.
Various committees in the past have suggested that the policy maintains its focus on controlling inflation rate. The Financial Sector Legislative Reforms Commission (FSLRC), 2013 (Chairman: B.N. Srikrishna) recommended that price stability is a desirable goal in its own right, particularly in India where inflation is known to hurt the poor. Thus, the central bank must be given a monitor-able quantitative objective by the Central Government for its monetary policy function.
From the cross-country experience, the appraisal of India’s monetary policy against the test of outcomes and the recommendations made by previous committees, the Urjit Patel Committee recommends that inflation should be the nominal anchor for the monetary policy framework. The monetary policy should be consistent with sustainable growth trajectory and financial stability subject to the establishment and achievement of the nominal anchor. The policy targets to maintain the nominal anchor around a 4% with a band of +/-2% in view of shock vulnerabilities and to avoid deflation bias.
The Committee further recommends that the RBI should adopt the new CPI (combined) as the measure of the nominal anchor as it closely reflects the cost of living and influences inflation expectations relative to other available metrics. The WPI, which has long been the metric for inflation in India, is an imperfect substitute for a producer price index (PPI) as it ignored the price movements in non-commodity producing sectors like services, which constitute close to two-thirds of economic activity in the country. It also does not generally reflect price movements in all wholesale markets as the price quotes of some of the important commodities like milk, LPG and the like are basically taken from retail markets.
Yutika is a second semester student of M.Sc. Economics at TERI University, Vasant Kunj. She has graduated in Statistics from Ramjas College, University of Delhi. The interest in subject encouraged her to pursue Masters in Economics. She likes to read, dance and play badminton. She has worked as an associate analyst in the quality and risk management department in Ernst & Young, GSS, Gurgaon for a span of 8 months post her graduation.
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