Inflation Targeting in India: An Interim Assessment

This paper provides an assessment of India’s inflation targeting regime. It shows that the Reserve Bank of India (RBI) is best characterized as a flexible inflation targeter: contrary to criticism, it does not neglect changes in the output gap when setting policy rates. The paper does not find that the RBI became more hawkish following the transition to inflation targeting; on the contrary, adjusting for inflation and the output gap, policy rates became lower, not higher. Some evidence suggests that inflation has become better anchored: increases in actual inflation excite inflation expectations less, which is indicative of improved anti-inflation credibility. The question is whether the shift to inflation targeting has enhanced the credibility of monetary policy such that the RBI is in a position to take extraordinary action in response to the COVID-19 crisis. The paper argues that the rules and understandings governing inflation targeting regimes come with escape clauses, allowing central banks to suspend their inflation targets temporarily under specific circumstances such as those provided by the COVID19 pandemic. The paper provides evidence that inflation targeting central banks were able to respond more forcefully to the COVID-19 crisis, consistent with the idea that inflation expectations were better anchored, providing more policy room for maneuver..