RBI must opt for soft inflation targeting

Says C. Rangarajan in this interview.

Do you recommend inflation targeting as a mandate for RBI?

There is a problem about making a specific number an inflation target. Emerging economies such as India are subject to serious supply shocks. These supply shocks normally come from agriculture, but sometimes the supply shock can come as a result of international commodity prices such as crude oil. In those situations, achieving a certain fixed target may become very difficult.

I will not opt for hard inflation targeting, but I would say that we must opt for soft inflation targeting, in the sense price stability must become the most dominant objective of monetary policy. I think there are several objectives of economic policy. Growth is one of them, price stability is another, and there are various instruments that are available—fiscal policy, monetary policy, direct intervention and so on and so forth—but the objective for which monetary policy is best suited is to control prices.


Rangarajan has been wanting inflation targeting for a while. However, recent Governor has clarified many times why inflation targeting for India  is not possible.

Since the crisis, inflation targeting was questioned for its single minded focus on price and missing the rest. Lars Svensson has popularised the idea of flexible inflation targeting. He says:

The Riksbank and all the other inflation-targeting central banks conduct flexible inflation targeting rather than strict inflation targeting. Flexible inflation targeting means that monetary policy aims at stabilizing both inflation around the inflation target and the real economy,  whereas strict inflation targeting aims at stabilizing inflation only, without regard to the  stability of the real economy, what Mervyn King (1997) has described as being an “inflation nutter”. By stabilizing the real economy I mean stabilizing resource utilization around a  normal level, keeping in mind that monetary policy cannot affect the long-term level of  resource utilization.

Now this soft inflation target idea by Rangarajan…Reading it closely, I gather he proposed government re-drafting RBI law and make inflation as its top priority over other objectives. As of now, the RBI objective/mandate is pretty broad and opaquely worded:

Thee preamble to the RBI Act, 19342 describes its main functions as “…to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.

Apart from this nice interview on other issues as well- growth-inflation trade-off, RBi behind the curve, bank regulation, new banks etc.

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