Macroeconomics

Inflation targeting and interest rate rules

Liquidity Adjustment Facility

TAYLOR’S RULE

• Constants are assumed to be 0.5

• Target inflation(Consumer): 5%

• Potential GDP measurement: Hordrick – Prescott

RBI’S MONETARY POLICY REVIEW

OPEC:

Crude oil

price at $68

Current CPI of

October: 5.52%

Forecast of

March 2015: 6%

Long Target

inflation: 5%

Current GDP of

Q2: 5.3%

Growth projection:

5.5%

IMF forecast of

potential GDP:

6.75-7.0%

Other factors affecting decision

Int – Inv –

AD – Y Inflation expectation

elevated,

Forecasted lower

Kharif o/p,

Depreciation of

rupee to 62.03

PMI index by

HBSC at peak:

53.1

FLEXIBLE INFLATION TARGETING

Aims at stabilizing both inflation(around it’s target) and the real economy

Primarily concerned with factors like

stability of interest rates

exchange rates

output

Employment

stabilizing resource utilization around a normal level

How quickly the central bank tries to bring inflation back to the targeted rate after

a deviation

Urjit Patel Committee Report points out moving towards a flexible inflation

targeting regime:

Anchors inflation expectations

Benefits including fiscal stability and low output volatility

Improves overall macroeconomic stability

Enhances growth prospects in the medium run

Allows the inflation to deviate from the target in the short run to

accommodate growth concerns.

CONTD…

Challenges: Managing the impossible trinity

Inflation metric to use as a target

Appropriateness of the numerical target

Impact of fiscal dominance

Absence of well-developed capital markets and accurate forecasting

techniques

Difficulties lies in defining and estimating the relevant measure of

“potential output”

Reduce the credibility of the inflation target.

NOMINAL GDP TARGETING IN INDIA

– AN ALTERNATIVE TO INFLATION TARGETING

Long-standing debate on the benefits and costs involved in

inflation targeting

Revived interest in NGDP targeting, as an alternative to

inflation targeting

Focused on advanced economies such as the US, Euro and

Japan where interest rates are ‘zero lower bound’

Developing countries have more acute need of monetary

policy credibility

Announcing a strict inflation target that is then repeatedly

missed would tend to erode credibility

Developing countries are more susceptible to adverse supply

shocks and trade shocks and thus can benefit most from an

NGDP target

EFFECT OF SHOCKS ON DIFFERENT TARGETING & INDIA’S POSITION

QUESTIONS YET TO BE ANSWERED -

Monetary authorities may not be able to hit the target, even if

a new target is set on an annual basis just like Inflation targets

The central banks cannot target an economic statistics that is

regularly revised

The McCallum Taylor Rule is akin to the NGDP targeting i.e. it

may already be a part of India’s policy setting

Thank You