Inflation Targeting

Every five years, the government of India, in coordination with the Reserve Bank of India, sets the inflation target for the economy. This rate of inflation has a margin of two percent at both ends to allow for flexibility and unforeseen circumstances. The aim of this limit is to ensure that inflation does not rise above set limits and neither does it fall down below the lowest limit. This allows the government control over the inflation rate in the economy.

What is inflation targeting?

When we talk about inflation targeting, we are talking about the approach of the government of the RBI towards long-term economic planning in the country. It should be noted that India ranks exceptionally well in being able to control inflation and the fluctuation in prices.

This comparison is in relation to countries like Indonesia, the Philippines, Korea, etc. Our neighboring countries are the first ones to come to our minds when we talk about comparative growth. This excellent performance in controlling prices has made India a relatively stable and safe market for investment.

The concept of inflation targeting was deemed a necessity when one looked over the trend in prices over the period, excluding this measure. Before a fixed target, the government had lesser measures to adopt to control the haywire behavior of the economy and the change in prices. Now when the prices fluctuate, the government knows when to step in and when to let the market take its corrective actions.

Who sets the inflation target in India?

The inflation targeting in India is set by both the RBI and the Government of India. They decide what the targeted inflation should be for the coming period of five years. And at the end of every five years, they come together again to set this limit. The inflation target is decided by the RBI and then conveyed to the government, where it meets the queries and revisions of the government. 

The question of who sets the inflation target in India is important also because it is a major deciding factor in the determination of the GDP of the nation. In addition to forecasting the CPI, the inflation target also has an effect on the forecast for the GDP. The measures that the government takes to implement the target inflation also have an effect on production.

How does it impact the economy?

Inflation targeting in India is a key factor in determining production because it affects our factors of production. The government will take steps to keep the rate of inflation within the specified limits, and these steps will have economic implications. Normally, these implications could just tide over with the invisible hand of the market at play, but the fiscal and monetary policies of the government make sure that the target is not breached. 

Thus, any producer will have to revise their manufacturing process and plan their investment, keeping in mind the policies of the government. A high rate of inflation will call for the devaluation of the currency, a move to ensure that the demand for goods will fall. When the demand falls, the production level will have to be scaled down too.

On the other hand, if the rate of inflation is falling, then the government will put in place measures that will reevaluate the currency and increase its demand. This will ensure that the demand for goods increases as people can now afford more goods with their limited income. 

Economic planning:

As a tool, inflation targeting is an excellent measure. It gives the government foresight to step in and regulate the market when they see the rate of inflation breaching the set limits. This timely intervention prevents the economy from crashing and the rate of inflation from spiraling outside control. This approach has been a huge success in India. RBI has been a pillar of stability for our young economy and has played a huge role in stabilizing the markets of the nation.

The RBI has managed to achieve economic stability and has played the role of a central bank, a banker to the government perfectly. At the end of every five years, its review committee goes over the data accrued over the elapsed period and studies it for discovering any scope of improvement. This practice allows them to come up with a better plan of action for the coming five-year period. 

Conclusion

In India, inflation targeting is done in consultation with the RBI to achieve a growth rate that is suitable for the development of the nation. In the absence of such a suitable growth rate, the economy will go on a downward trend as, without an increase in prices, the producers will lose the motivation to continue production in the face of the rising cost of manufacturing. Inflation targeting is also done so that the rate of inflation does not go out of the control of the government.