Lower inflation beneficial for financial stability, says RBI study

A Reserve Bank of India (RBI) study on May 24 emphasised that lower inflation is beneficial for the financial stability in the economy and will have favourable redistribution effects on the economically poorer sections of the society.

"Lower inflation has favourable redistribution effects particularly on the poor and is beneficial for financial stability. These costs and benefits of fixing a long-term inflation target will thus have to be considered while making the choice, the study said.

The study, titled 'Threshold Level of Inflation – Concept and Measurement', is co-authored by Ravindra H. Dholakia, Jai Chander, Ipsita Padhi and Bhanu Pratap. The study examined the concept of threshold inflation and defined it as the long run equilibrium rate of inflation that maximises the steady state growth within the relevant range of values.

The retail inflation, which is used by the monetary policy committee (MPC) for policy formulation, has stayed at an elevated level for a prolonged period causing a policy dilemma to the central bank, before showing signs of easing in the recent months. With the growth yet to recover from the Covid-impact and inflation staying close to the upper band, the MPC has been on a pause mode.

With the Covid resurgence in the second wave, there is a fear that inflation may spike yet again in the approaching months.

The Consumer Price Index (CPI)-based inflation eased to 4.29 per cent in the month of April compared with 5.52 per cent in March. The MPC has a medium term inflation target of four per cent on CPI inflation with a margin of two per cent on either side. This is the fifth consecutive month the CPI inflation has fallen within the central bank's target range.

The MPC has cut rates by 250 basis points (bps) since February, 2019 to support growth. One bps is one hundredth of a percentage point.

The RBI study has sought the setting of long-term targets for real growth, inflation rate, fiscal deficit and current account deficit on balance of payments as a proportion of GDP in order to optimise macroeconomic management.

“Unless internally consistent targets for all these four macro parameters are set, the macroeconomic policies to achieve these targets individually would always result in shortfalls, sub-optimal outcomes and wastage of efforts and resources,” the authors stated in the executive summary of the study.

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Credit: Money Control | MAY 24, 2021