Monetary policy measures are taken with future projections of inflation and growth rather than data of the past, Reserve Bank of India Governor Shaktikanta Das said, highlighting that recent inflation numbers would weigh less than what it expects to be in the medium term.
“As monetary policy works with long and variable lags, the forecasts of key macroeconomic variables play a vital role in the conduct of monetary policy. It is for this reason that inflation targeting framework is also termed as “inflation forecast targeting” framework,” said Das, taking a real-life analogy and saying that monetary policy is like driving a car on a road with potential ditches and speedbumps. “The driver needs to see them ahead and in time to regulate the speed of his car and to negotiate the ditch or speedbump smoothly.”
Rear view mirror can lead to policy errors, he said, adding that frequent supply shocks pose a major challenge in inflation management and anchoring inflation expectations.
“We look though fleeting shocks but remain prepared to undertake policy responses if such shocks show signs of persistence and getting generalised. In such a scenario, monetary policy has to focus on containing the second round effects,” Das said Tuesday at an Delhi School of Economics event.
The central bank kept the repo rate unchanged in August, despite the sharp rise in vegetable prices which led the inflation print for July to surge to 7.4%. The good news is that the prices have already started moderating.
Das said that the cumulative 250 basis points rise in repo rate since May 2022 is still working through.
Headline inflation had eased to 4.8% in June 2023 from the peak of 7.8% in April 2022, before the July spurt.
The RBI maintained a pause in the April, June and August 2023 monetary policy meetings.
“Our experience in recent years shows that supply shocks have become more frequent with profound implications for inflation management and anchoring of inflation expectations. A key risk of sustained high inflation is that it can de-anchor inflation expectations. It is, therefore, important to remain vigilant and take necessary steps in a calibrated and timely manner to keep expectations firmly anchored.”
The governor also talked about the importance of supply side interventions in minimising the severity and duration of the vegetable price shocks.
“In these circumstances, it is necessary to be watchful of any risk to price stability and act timely and appropriately. We remain firmly focused on aligning inflation to the target of 4%,,” Das said, addressing the DSE students.
To be sure, price stability and financial stability always complements each other.
Sometimes, the trade-off between the two becomes a close call as demonstrated in the recent bank collapses in the US.
However, the RBI governor assured that the Indian banking and financial system is robust with strong capital base.
