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'Inflation target should be maintained at 4%'
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SME Times News Bureau | 29 Dec, 2020
India's inflation target should be maintained at 4 per cent in the
medium term, according to a working paper by the Reserve Bank of India
(RBI).
The paper, published by the RBI's Department of Economic
and Policy Research, noted that central to monetary policy is the
concept of 'Trend Inflation' to which actual inflation outcomes are
expected to converge after short-run fluctuations die out.
Accordingly,
the inflation target needs to be fixed in alignment with trend
inflation to avoid unhinging inflation expectations and flattening the
aggregate supply curve or imparting a deflationary bias to the economy.
"Results
from a regime switching model applied to a 'hybrid New Keynesian
Philips' curve suggest a steady decline in trend inflation since 2014 to
4.1-4.3 per cent just before Covid-19 struck. This points to
maintaining the inflation target at 4 per cent for India," the paper
authored by Harendra Kumar Behera and Michael Debabrata Patra of RBI.
The paper added the decline in trend inflation since 2014 is, however, coincident with a flattening of the 'Philips Curve'.
Trend inflation provides key insights for monetary policy committee in at least three important ways.
The Phillips curve is an economic concept that shows that inflation and unemployment have a stable and inverse relationship.
"First,
the level and variability of trend inflation indicate how anchored
inflation expectations are. Second, it is a valuable gauge of the
appropriateness of the monetary policy stance and the necessity or
otherwise of additional monetary policy actions to achieve steady state
inflation," it said.
Third, trend inflation provides a centering
point for the evaluation of inflation forecasts over various time
periods and, this in turn, can usefully inform the setting of monetary
policy.
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Customs Exchange Rates |
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