Inflation

Public borrowing is essential to garner resources to combat the current pandemic. The ability to do so and adhere to the standard norms of debt sustainability will be harder for developing economies as compared to the developed, due to constraints, both structural and policy-induced. High food infl ation and the adoption of infl ation targeting will impose severe constraints on the ability to expand borrowing and maintain low levels of debt-to-GDP. In such a situation, governments must either rethink monetary policy and/or allow for debt ratios to rise. 

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This paper argues that, over the longer run, the intertemporal path of inflation in an economy is affected by secular changes in the inter-sectoral terms-of-trade, which in turn, is closely linked to the stages of structural change. This linkage is investigated through simple devices of consumer choice and growth. Results imply that monetary authorities’ inflation targets should optimally account for such secular changes in the terms-of-trade, over and above the terms-of-trade shocks observed typically in developing economies.

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The recently published Report on Currency and Finance, 2020–21 of the Reserve Bank of India reviewed the performance of the flexible inflation targeting regime in India. In the light of stylised facts, cross-country experience, and detailed econometric results, the report seemed to suggest that despite several shocks (like demonetisation or introduction of the goods and services tax), a combination of good policy and luck have worked in favour of the success of the FIT regime in India. Going forward, while advocating some nuanced, subtle changes in the operation and administration of the FIT regime, the report called for its continuation as a strategy of monetary policy in India.