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The announcement of an official target range for inflation is known as inflation targeting. It is done by the Central Bank in an economy as a part of
their monetary policy to realise the objective of a stable rate of inflation36 (the Government of India asked the RBI to perform this function in the early 1970s).
India commenced inflation targeting ‘formally’ in February 2015 when an agreement between the GoI and the RBI was signed related to it—the Agreement on Monetary Policy Framework. The agreement provides the aim of inflation targeting in this way—’it is essential to have a modern monetary framework to meet the challenge of an increasingly complex economy. Whereas the objective of monetary policy is to primarily maintain price stability, while keeping in mind the objective of growth.’ The highlights of the agreement is as given below:
1. The RBI will aim to bring CPI-C Inflation below 6 per cent by January 2016. The target for financial year 2016–17 and all subsequent years shall be 4 per cent with a band of +/- 2 per cent (it means the ‘healthy range of inflation’ to be 2–6 per cent).
2. RBI to publish the Operating Target(s) and establish an Operating Procedure of monetary policy to achieve the target. Any change in the operating target(s) and operating procedure in response to evolving macro-financial conditions shall also be published.
3. Every six months, the RBI to publish a document explaining:
(a) Source of inflation;
(b) Forecasts of inflation for the period between six to eighteen months from the date of the publication of the document; and
4. The RBI shall be seen to have failed to meet the target if inflation is:
(a) More than 6 per cent for three consecutive quarters for the financial year 2015–16 and all subsequent years.
(b) Less than 2 per cent for three consecutive quarters in 2016–17 and all subsequent years.
5. If the RBI fails to meet the target it shall set out in a report to the GoI:
(a) the reasons for its failure to achieve the target under set in this agreement;
(b) remedial actions proposed to be taken by the RBI; and
(c) an estimate of the time-period within which the target would be achieved pursuant to timely implementation of proposed remedial actions.
6. Any dispute regarding the interpretation or implementation of the agreement to be resolved between the Governor, RBI and the GoI.
It should be noted that the Urjit Patel Committee set by the RBI on monetary policy gave similar advices by early 2014—the move is seen as a follow up to this. This way India joined the club of inflation targeting countries such as USA, UK, European Union, Japan, South Korea, China, Indonesia and Brazil. It was New Zealand which went for inflation targeting in 1989 for the first time in the world.37
Economists usually distinguish between inflation and a relative price increase. ‘Inflation’ refers to a sustained, across-the-board price increase, whereas ‘a relative price increase’ is a reference to an episodic price rise pertaining to one or a small group of commodities. This leaves a third phenomenon, namely one in which there is a price rise of one or a small group of commodities over a sustained period of time, without a traditional designation. ‘Skewflation’ is a relatively new term to describe this third category of price rise.
In India, food prices rose steadily during the last months of 2009 and the early months of 2010, even though the prices of non-food items continued to be relatively stable. As this somewhat unusual phenomenon stubbornly persisted, policymakers conferred on how to bring it to an end. The term ‘skewflation’ made an appearance in internal documents of the Government of India, and then appeared in print in the Economic Survey 2009–10 GoI, MoF.
The skewedness of inflation in India in the early months of 2010 was obvious from the fact that food price inflation crossed the 20 per cent mark in multiple months, whereas wholesale price index (WPI) inflation never once crossed 11 per cent. It may be pointed out that the skewflation has gradually given way to a lower-grade generalised inflation (with the economy in the
middle of 2011 inflating at around 9 per cent with food and non-food price increases roughly at the same level).
Given that other nations have faced similar problems, the use of this term picked up quickly, with the Economist magazine (January 24, 2011), in an article entitled ‘Price Rises in China: Inflated Fears’, wondering if China was beginning to suffer from an Indian-style skewflation.
This is the ratio between GDP at Current Prices and GDP at Constant Prices. If GDP at Current Prices is equal to the GDP at Constant Prices, GDP deflator will be 1, implying no change in price level. If GDP deflator is found to be 2, it implies rise in price level by a factor of 2, and if GDP deflator is found to be 4 , it implies a rise in price level by a factor of 4. GDP deflator is acclaimed as a better measure of price behaviour because it covers all goods and services produced in the country (because the weight of services has not been equitably accounted in the Indian ‘headline inflation’, i.e., inflation at WPI).