Four years of MPC: Inflation estimates still a mug’s game

As it turns four this week, the Reserve Bank of India’s Monetary Policy Committee (MPC) will yet again attempt to crack the unsolved mystery of price stability.

Published: 01st October 2019 10:06 AM  |   Last Updated: 01st October 2019 10:06 AM   |  A+A-

Reserve Bank of India

Reserve Bank of India

Express News Service

HYDERABAD: As it turns four this week, the Reserve Bank of India’s Monetary Policy Committee (MPC) will yet again attempt to crack the unsolved mystery of price stability. ]

The country’s designated inflation nutter is evolving from its salad days, but continues to be praised less and criticised more, as monetary policymaking largely remained a mug’s game.  

The committee was constantly assailed for its misguided inflation forecasts, for pursuing a tight monetary policy until last year and for systematically missing its own price estimates. The assault will likely deepen should the chorus to revise RBI’s inflation target emerges stronger.

RBI is mandated to maintain headline inflation at 4 per cent, plus or minus 2 per cent for five years or until March 2021. A review of the MPC framework won’t be up until then (RBI Act allows evaluation once every five years), but catcalls are heard from economists like Dr Arvind Panagariya, who suggests that a little high inflation will be good for the country.

“The band is too broad, but that’s how typically all central banks started and gradually narrowed down. There’s a need to review, but instead of raising the target higher, I’d say, instead of 2-4-6, you could make it 3-4-5,” Prof Amol Agarwal, Ahmedabad University, told TNIE.

But pinballing from 4 per cent to above 4 may prompt markets and investors to pulsate with anxiety. Which is why global central banks have their hands tied at the back to adopt higher targets.

“Moreover, when developed countries are unable to maintain 2 per cent, how are they going to get to 3-4 per cent? With sustained lower inflation, are we living at a new normal? If it remains low, it means that we need more stimulus, but that leads to reaction in financial markets. So it’s not an easy call,” he reasoned.

RBI’s glide path brought down inflation from its peak of 11.5 per cent in November 2013 to sub-5 per cent in 2016, though much of it was due to good luck and fall in global crude prices.

But as we know, luck and low oil prices aren’t eternal. So in 2016, when policymaking was ceded to MPC, it was presumed that inflation assessment will be predictable.

In practice though, it has been a bit of meh, with MPC overestimating inflation often. But then, all central banks’ forecasts aren’t watertight.

“Most central banks have been consistently missing inflation estimates and that stands true for our MPC too,” Agarwal explained.

For instance, the US Federal Reserve has been missing the tiny band of 2 per cent since its adoption in 2012, while the European Central Bank has been undershooting its 2 per cent objective for nearly a decade. Ditto with Japan, which consistently missed it for over 30 years.

If with the current policy, the inflation is bordering at 3-3.5, what should a higher inflation band signal? Is it the end of RBI’s accommodative stance because inflation is up? Or are further rate cuts in the pipeline? These are broader questions we must address, said Agarwal.

‘25 bps cut likely’

Goldman Sachs in a report on Monday said the RBI is likely to go for a further rate cut in the ensuing monetary policy review meet on October 4, amid weak economic activity and benign inflation.

RBI mpc


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