Does Inflation Targeting Really Work?

- Impact of geopolitical disputes on crude and various food and commodity markets

In most developed countries, the inflation target is two percent. But consumer price inflation is 3.7 percent in the US, 5.6 percent in the euro zone, 6.8 percent in Britain and 2.9 percent in Japan. In Germany, which is struggling with zero growth, it is 4.3 percent. In India, where the rate of inflation is much higher than in these developed countries, the rate is 5 percent. The rate of 5 percent is higher than the Monetary Policy Committee's target of 4 percent. The evidence suggests that inflation targeting works only when the world economy is in a normal state and demand fluctuations are in short cycles that monetary policy can deal with.

Geopolitical disputes have affected the oil market and various food and commodity markets. This upheaval will continue as the world continues to fragment into competing blocs seeking to reset the tipping point. Climate change problems generate other types of costs. In such a situation, the price will rise even though the demand is weak. Monetary policy has no answer in this situation. Those in charge use the rhetoric of prolonged high interest rates to hide their incompetence.

Despite the good performance of America and China, there is a global recession. The high cost of loans is putting pressure on the books of banks and companies. In such a situation, their influence is likely to expand. Investment is being affected as higher returns have to be made to cover the higher cost of capital. The situation is more difficult for countries that have a lot of debt and are burdened with interest. High interest rates on economic capital also affect surrounding markets because global capital needs protection. This also affects markets like India.

Monetary policy is at a crossroads. The United Nations Conference on Trade and Development, in its latest annual report on trade and development, said central banks should abandon their stated two percent target and focus on other issues such as the debt crisis, rising inequality and slowing growth when making policy.

Similar arguments were given in India when the target of 4 percent was set. There are many causes of inflation and excess demand is one of them. In such a scenario, the Reserve Bank does not have such policy measures to achieve the single point target. Some argue that such an attempt would also be misguided because other macroeconomic goals are just as important.

India's position is better than other countries. India does not have much debt and the pace of growth is better. In such a situation, the Reserve Bank has scope to raise rates and try to achieve the target of 4 percent. However, the Reserve Bank has kept its hands off and predicted that the inflation target will not be achieved in the next three quarters.

The question here is that if the 4 percent inflation target is not achieved by 2019, then how relevant is it to maintain it? What good would it be if the goal was achieved only by chance? Given this, it is not out of place to say that inflation targeting has any meaning in India, right?