Rangarajan underscores need for flexible inflation target

C Rangarajan, chairman of Economic Advisory Council, Government of India, today stressed the importance of a flexible inflation target in conducting the monetary policy.

He was addressing the seventh annual conference in money and banking in Indian economy hosted by the Indira Gandhi Institute of Development Research (IGIDR).

Benjamin Friedman of Harvard university in his recent address at the Reserve Bank of India had preferred clear outlining of policy objectives to maintain more transparency in policy formulation of central banks rather than inflation targeting which turns out to be non transparent process in the long run.

Rangarajan today said that in an economy with high inflation and high interest rate, growth can be managed as well as real interest rate for the savers. "It all depends what you expect. There were times when there was investment boom even at high rate of interest," he said.

Highlighting the importance of inflation targeting, he said the target should be explicitly enunciated so that the central banks could judge their performance regarding the maintaining the monetary objectives.

"After all, central banking is not about applying well known techniques to well known problems. It is about understanding the functioning of the economy to handle it better," he stated.

On his view on balancing growth and price stability, Rangarajan said that in the medium term there is no conflict but in the short term, a threshold rate of inflation should be maintained. "During my times, I had a threshold level of 5-6 per cent beyond which if the inflation rate goes, the negative effects start accruing to the economy," he said.

While inflation is high, reigning in inflation below the threshold level should be broader objective. However, when inflation is low, facilitating growth is prime concern, he added.

The monetary targeting by the central bank in India has changed in the recent times with change of the monetary regime from an administered one to a deregulated one. In an administered interest rate regime, money supply used to be a significant indicator. Similarly, in an deregulated regime, interest rate has increasingly become important.

Similarly, when inflation rate is very, money supply is good indicator while at low interest rate scenario, interest rate is a better one. It all depends what regime we are operating in, Rangarajan added.