Inflation Targeting in India : An Interim Assessment

This paper provides an assessment of India’s inflation-targeting regime. It shows that the Reserve Bank of India is best characterized as a flexible inflation targeter: contrary to criticism, it does not neglect changes in the output gap when setting policy rates. The paper does not find that the Reserve Bank of India became more hawkish following the transition to inflation-targeting; to the contrary, adjusting for inflation and the output gap, policy rates became lower, not higher. Some evidence suggests that inflation has become better anchored: increases in actual inflation do less to excite inflation expectations, indicative of improved anti-inflation credibility. The question is whether the shift to inflation-targeting has enhanced the credibility of monetary policy such that the Reserve Bank of India is in a position to take extraordinary action in response to the Covid-19 crisis. The paper argues that the rules and understandings governing inflation-targeting regimes come with escape clauses allowing central banks to shelve their inflation targets temporarily, under specific circumstances satisfied by the Covid-19 pandemic. The paper provides evidence that inflation-targeting central banks were able to respond more forcefully to the Covid-19 crisis, consistent with the idea that inflation expectations were better anchored, providing more policy room for maneuver.