Highlighting the crucial connection between the current high levels of inflation and the expectation among consumers that prices will continue to rise as sharply in the future, the Reserve Bank of India has pointed out that since headline and core inflation have overshot even the most pessimistic projections, there is a concern that inflation expectations might become unhinged. Indeed, anchoring inflation expectations at a low level has become one of the most daunting challenges of monetary policy. Reeling under high food inflation many households do not see any respite even in the year ahead. The same despair permeates the outlook on fuel prices as well, probably with an even greater justification. While global oil prices have been ascendant, they are not fully reflected in the domestic fuel prices. Both inflation and inflation expectations are conditioned by certain well known instruments of public policy. There should be a clearly stated inflation objective for macroeconomic policy and management, and also for monetary policy. Secondly, central banks must deploy a credible range of monetary instruments which they must be able to refine as and when necessary. Thirdly, conditions ought to be created for the proper transmission of the policy action. In India the RBI is responsible for controlling inflation, but the government has an important role in influencing supply-side factors.
Sound inflation management demands that the central bank and the government work in tandem even if, at a particular juncture, inflation is attributable to a factor over which only one of them has influence. Thus, even when on many a recent occasion inflation was being pumped up chiefly by food prices, the RBI expressed its resolve to back government action with monetary measures even if those were not clearly indicated. The major measures announced in the recent RBI monetary policy statements are noteworthy. For instance, the 0.75 percentage point increase in the repo rate over six weeks, making the repo rate the sole policy rate, and the creation of the new Marginal Standing Facility from which banks can borrow at one percentage point above the repo rate are all decisive steps in the context of inflation management. It is highly significant that even when the RBI lowered the growth estimates and increased those of inflation thereby differing sharply from the official position, the government has backed the central bank. More realistic growth and inflation estimates, and greater cohesion between the government and the RBI are all vital ingredients in a well thought out strategy of controlling inflation and anchoring inflation expectations.
