Inflation Target Breach

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    In News

    • Recently, the Reserve Bank of India said that it will call a special meeting of its Monetary Policy Committee (MPC) soon explaining the reasons for the average retail inflation remaining above the upper tolerance limit of 6 per cent for three consecutive quarters. 

    Background 

    • The RBI Act 1934 was amended in 2016 giving effect to this monetary policy framework agreement. 
    • The framework agreement requires the RBI to submit a report to the Union government if it is in breach of the inflation targets for three consecutive quarters.  

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    Recent Data

    • The average retail inflation in January-March 2022 and April-June 2022, according to data released by the National Statistics Office, was 6.34 per cent and 7.28 per cent, respectively. 
    • In July this year, it stood at 6.71 per cent.

     

    Inflation Targeting in India 

    • The RBI has announced a formal review of the policy instrument after six years of the Urjit Patel report (2014) on inflation and the use of inflation targeting.
    • The primary goal of IT was to contain inflation at around 4 per cent, within the allowable range of 2 to 6 per cent.

    Main causes of inflation

    • Monetary Policy: It determines the supply of currency in the market. Excess supply of money leads to inflation. Hence decreasing the value of the currency.
    • Fiscal Policy: It monitors the borrowing and spending of the economy. Higher borrowings (debt) result in increased taxes and additional currency printing to repay the debt.
    • Demand-pull Inflation: Increases in prices due to the gap between the demand (higher) and supply (lower).
    • Cost-push Inflation: Higher prices of goods and services due to increased cost of production.
    • Exchange Rates: Exposure to foreign markets is based on the dollar value. Fluctuations in the exchange rate have an impact on the rate of inflation.
    • Demand-supply gap: High demand and low production or supply of multiple commodities creates a demand-supply gap, which leads to a hike in prices.

    How do we prevent inflation?

    • Change the monetary policy: The primary strategy is to change the monetary policy by adjusting the interest rates. Higher interest rates decrease the demand in the economy. This results in lower economic growth and therefore, lowers inflation.
    • Controlling the money supply can also help in preventing inflation.
    • Higher Income Tax rates can reduce spending, hence resulting in lesser demand and inflationary pressures.
    • Introducing policies to increase the efficiency and competitiveness of the economy helps in reducing the long term costs.
    • Invest in long-term investments: When it comes to long-term investments, spending money now for investments can allow you to benefit from inflation in the future.

    Effects of a rise in the inflation rate

    • Inflation could lead to economic growth as it can be a sign of rising demand.
    • Inflation could further lead to an increase in costs due to workers’ demand to increase wages to meet inflation. This might increase unemployment as companies will have to lay off workers to keep up with the costs.
    • Domestic products might become less competitive if inflation within the country is higher. It can weaken the currency of the country.  

    Way Forward/ Suggestions

    • Strength: India faces these challenges from a position of strength built on broadened vaccine coverage, financial sector resilience, robust export and remittances and fiscal reprioritization to spur capital spending on infrastructure.
    • Spurring private investment: remains a key thrust area for sustaining growth on a durable basis.
    • The third wave seems to be behind: with the removal of all curbs, alongside a broadening of vaccination, economic activity is returning to speed.
    • Most sectors are reaching or have exceeded pre-pandemic levels: Bank credit has gathered pace and the job market is gathering steam.
    • Growing GST collections: Is an indicator of growth in the segment of the economy that collects the tax.

    About Monetary Policy Committee (MPC)

    • Section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette.
    • Chaired by the Governor of RBI. 
    • Mission: Fixing the benchmark policy interest rate (repo rate) to restrain inflation within the particular target level (2% to 6%). 
    • MPC conducts meetings at least 4 times a year. 
    • The monetary policy is published after every meeting with each member explaining his opinions.

    Source: IE