Flexible Inflation Targeting: A Good Balance

The Hindu Editorial Analysis
15 November 2025

Flexible Inflation Targeting: A Good Balance

(Source – The Hindu, International Edition – Page No. – 8)

Topic : GS Paper III: Indian Economy – Monetary Policy, Inflation & Growth | GS Paper II: Government Policies & Institutional Frameworks

Context

India’s Flexible Inflation Targeting (FIT) framework, introduced in 2016 under the amended Reserve Bank of India (RBI) Act, set a target of 4% inflation with a tolerance band of ±2%. This mandate is due for review in March 2026.
The article analyses whether this framework has successfully balanced price stability and economic growth, and what adjustments might be needed for the next phase.

Background: Evolution of Inflation Targeting

• Inflation targeting became prominent after the Chakravarty Committee (1985) and was institutionalized post-2016 with the creation of the Monetary Policy Committee (MPC).
• The RBI was granted functional autonomy to pursue price stability while ensuring growth and employment.
• The framework’s credibility rests on maintaining inflation near 4%, ensuring predictability and investor confidence.

Key Issues in Debate

1. Headline vs. Core Inflation:
   • Should RBI target headline inflation (includes food and fuel) or core inflation (excludes them)?
   • The authors argue that headline inflation better reflects the cost of living and savings impact, especially in India where food accounts for a major share of household expenditure.
2. Acceptable Inflation Level:
   • Empirical evidence (1991–2023) shows a non-linear relationship between inflation and growth, with optimum growth at ~4% inflation.
   • Thus, reducing inflation below 4% may not yield extra growth and could even hinder investment.
3. Inflation Band:
   • The ±2% tolerance band (i.e., 2–6%) provides operational flexibility to the RBI.
   • The framework has worked well despite multiple global shocks (pandemic, supply chain disruption, oil crisis).

Policy Considerations

• Phillips Curve Trade-off: The relationship between inflation and unemployment still holds partially; very low inflation could dampen job creation.
• Fiscal-Monetary Coordination: Inflation targeting must be complemented by prudent fiscal management; otherwise, supply-side inflation can persist despite monetary tightening.
• Autonomy and Accountability: The RBI’s independence must be protected, but transparency in decision-making should continue to ensure public trust.

Way Forward

1. Maintain 4% as the Nominal Anchor: It balances growth and stability without excessive contraction.
2. Review the Band, Not the Target: Given structural shifts, the 2–6% range remains reasonable.
3. Enhance Communication: Clear public guidance from the MPC can anchor expectations and prevent market panic.
4. Focus on Supply-side Stability: Strengthen logistics, agriculture, and energy policies to prevent cost-push inflation.

Conclusion

The Flexible Inflation Targeting (FIT) regime has largely succeeded in stabilizing India’s macroeconomic environment.

“Inflation control is not an end in itself, but a means to promote sustained growth and financial confidence.”

A cautious recalibration—not replacement—of the FIT framework is the ideal path as India approaches its 2026 policy review.

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