A political shield for inflation warriors - Hindustan Times
close_game
close_game

A political shield for inflation warriors

Sep 05, 2022 08:04 PM IST

World over, central banks understand the need FLAto engineer a mild recession to avoid a stagflationary trap and are confident to make this step public. In India, the tradition of shooting the messenger prevents RBI from delivering this message emphatically. This needs to change

The global economic outlook appears bleak today, with growth likely to slow down in the two largest economies, the United States (US) and China. Europe faces a grim winter, with uncertainty around Russian fuel supplies. India’s growth performance appears healthier than that of most other large economies at the moment. But the global growth slowdown is unlikely to spare India. Net exports dragged growth down in the June-ended quarter. As global demand weakens further, expect this trend to persist.

RBI should view the inflation-targeting law as a political and constitutional shield for doing its job, rather than as some kind of shaming mechanism. It should use the law to stick to its core mandate of price stability (MINT) PREMIUM
RBI should view the inflation-targeting law as a political and constitutional shield for doing its job, rather than as some kind of shaming mechanism. It should use the law to stick to its core mandate of price stability (MINT)

The growth slowdown will complicate the Reserve Bank of India (RBI)’s fight against inflation. Typically, a fall in demand eases price pressures and allows a central bank to focus more on growth than inflation. But this time is different. Global food and fuel shortages, accompanied by heightened expectations of inflation, could keep prices high even as demand weakens, a phenomenon economists describe as stagflation.

The economic scenario today resembles the 1970s, when another supply shock drove the world into a stagflationary trap. The big macroeconomic lesson from the 1970s was that policymakers need to prioritise the fight against inflation when faced with the twin threats of high inflation and slow growth. Else, the economic costs in terms of lost output and livelihoods can be devastatingly high, as it was in the 1970s.

Hopefully, the policy response will be more decisive this time. Modern-day central bankers have grown up studying the mistakes made in the 1970s. They understand that they may need to do all it takes to prevent a stagflationary trap, even if that means engineering a mild recession.

Central bankers in the West are confident enough to say this out loud without fear of repercussions. In India, the hoary tradition of shooting the messenger prevents RBI officials from delivering this message emphatically. But the trade-off is stark. Unless India is prepared to accept some reduction in growth induced by monetary contraction, it will face a long era of stagflation.

Thankfully, India’s institutional setup today allows RBI to focus on its core mandate of price stability. As this column has pointed out earlier, RBI was slow to react to the inflation threat but it shifted gears in May. India’s inflation-targeting law enacted in 2016 prescribes an inflation target of 4% (with +/-2% deviation allowed). The law said that RBI should produce a report outlining remedial measures when inflation breaches the thresholds.

Like any other law, this too can be gamed. The finance ministry worked with RBI to ensure that the central bank didn’t have to produce the mandated remedial report when inflation targets were breached in 2020, right to information (RTI) replies obtained by journalist Somesh Jha showed. Officials feared that remedial measures to check inflation could jeopardise the country’s economic recovery when it was still reeling from the impact of the initial Covid-19 lockdowns. Citing limitations in inflation data-gathering, RBI got away without submitting the mandated report.

The subversion of the law doesn’t mean it is meaningless. The exceptional circumstances of 2020 allowed our policymakers a free pass. They will find it difficult to evade the accountability clause in 2022.

On its part, RBI should view the law as a political and constitutional shield for doing its job, rather than as some kind of shaming mechanism. In a poor democracy such as ours, policymakers will always face pressures to bump up short-term growth through fiscal and monetary stimuli even if such measures jeopardise macroeconomic stability. The inflation-targeting mandate provides a countervailing mechanism against such populism.

Most economists agree that the inflation-targeting law has been a worthy reform, helping narrow the inflation differential between India and the rest of the world. But it is not without critics. The critics argue that there is no evidence to show that RBI has been able to anchor inflationary expectations in the country. Besides, inflation in India is driven by food and fuel prices, which RBI can’t control.

It is difficult to agree with the critics. Since India doesn’t collect reliable nationally representative data on inflation expectations, any empirical claim on household inflation expectations must be taken with buckets of salt. We shouldn’t confuse the absence of evidence with evidence of absence.

Food and fuel price spikes can be ignored when they change relative prices of these items compared to others. But when such price spikes spill over to other product markets, leading to a sustained rise in the overall price level, it provides a signal that inflation expectations may be getting entrenched. In such a scenario, a central bank needs to clamp down on demand to douse inflationary fires, even if it lacks precise data about household inflation expectations.

The inflation-targeting law is, of course, imperfect. But it is far from useless. RBI can and should use the cover of the law to stick to its core mandate of price stability. When the time comes to present an account of its failure to keep inflation under control this year, it should use the opportunity to educate the government and Parliament on the trade-offs involved in making fiscal and monetary choices. A well-informed public discussion on such issues will only help RBI do its job better in future.4

Pramit Bhattacharya is a Chennai-based journalist The views expressed are personal

Unveiling 'Elections 2024: The Big Picture', a fresh segment in HT's talk show 'The Interview with Kumkum Chadha', where leaders across the political spectrum discuss the upcoming general elections. Watch Now!

Continue reading with HT Premium Subscription

Daily E Paper I Premium Articles I Brunch E Magazine I Daily Infographics
freemium
SHARE THIS ARTICLE ON
Share this article
SHARE
Story Saved
Live Score
OPEN APP
Saved Articles
Following
My Reads
Sign out
New Delhi 0C
Friday, March 29, 2024
Start 14 Days Free Trial Subscribe Now
Follow Us On