Inflation targeting is a monetary policy framework where a central bank establishes a specific inflation rate to achieve and maintain economic stability. This approach ensures that inflation remains predictable, enabling effective long-term economic planning.
India formally adopted inflation targeting in 2016 through amendments to the Reserve Bank of India (RBI) Act of 1934. The model was inspired by New Zealand's pioneering approach introduced in 1990.
The target inflation rate set for India is 4%, with a tolerance band of ±2%. This means that inflation should ideally fluctuate between 2% and 6%.
The RBI employs various monetary policy tools to achieve the inflation target, primarily using the repo rate. When inflation rates rise, the RBI typically increases interest rates to reduce the money supply. Conversely, if inflation is low and economic growth slows, the RBI may lower interest rates to stimulate demand.
Prior to implementing inflation targeting, India's monetary policy lacked clarity and specific objectives. The persistent issue of high inflation and economic uncertainty led to the establishment of the Urjit Patel Committee in 2014, which recommended adopting a flexible inflation targeting system similar to that of New Zealand.
Similar to New Zealand, India grants operational independence to its central bank through the Monetary Policy Committee (MPC), but the target is set by the government in consultation with the RBI. Over 40 countries, including the UK, Canada, and Brazil, have adopted similar frameworks, though many are adapting them to address new challenges such as climate change and aging populations.
Q1. What does inflation targeting aim to achieve?
Answer: Inflation targeting seeks to control inflation rates, ensuring they remain stable and predictable, which aids in long-term economic planning and stability.
Q2. How often does RBI review the inflation target?
Answer: The RBI typically reviews the inflation target biannually during its monetary policy meetings, adjusting strategies as needed based on economic conditions.
Q3. What are the roles of the Monetary Policy Committee?
Answer: The Monetary Policy Committee (MPC) decides on the repo rate and other monetary policies to achieve the inflation target while considering economic growth and stability.
Q4. How does inflation targeting affect consumers?
Answer: Inflation targeting stabilizes prices, which helps consumers make informed financial decisions and reduces uncertainty about future costs.
Q5. What challenges does India face with inflation targeting?
Answer: India faces challenges like external shocks, supply-side inflation, and balancing growth with inflation control, which complicate the effectiveness of this framework.
Question 1: What is the main goal of inflation targeting?
A) Control government spending
B) Maintain stable inflation rates
C) Increase unemployment
D) Reduce foreign investment
Correct Answer: B
Question 2: When did India formally adopt inflation targeting?
A) 2001
B) 2010
C) 2016
D) 2020
Correct Answer: C
Question 3: What is the target inflation rate set by the RBI for India?
A) 2%
B) 4%
C) 6%
D) 8%
Correct Answer: B
Question 4: Who recommended adopting the inflation targeting framework in India?
A) Raghuram Rajan
B) Urjit Patel Committee
C) NITI Aayog
D) RBI Board
Correct Answer: B
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