Inflation measurement and inflation targeting in India

Abstract

Since its inception in 1989, Inflation Targeting has worked in a number of countries, and failed in some. There are contrasting views on Inflation Targeting from economists all around the world. Our paper aims to portray the different logic of economists highlighting both the pros and cons of Inflation Targeting. From the arguments used for and against Inflation Targeting, we also aim to deduce whether inflation targeting would be suitable for an emerging economy like India, or whether it is better off following the multi-variable approach it has now been following. For this, we have considered the numerous other factors affecting the economic equilibrium in the emerging countries, and how Inflation Targeting has fared in the few emerging countries that have adopted it. We have also tried to analyze whether there exists any significant correlation between Inflation Targeting and Sacrifice Ratio and Transmission Mechanism, particularly in the emerging market economies. One of the foremost challenges of adopting Inflation targeting as the sole economic policy is to adjudge which price index should be considered to target inflation, because different price indices are calculated in different ways, and consider different items. Ideally, to target inflation, the variable components of the price indices should be removed, yet it should be sufficiently representative of the economy. Various countries follow various indices, and vary the number of items they consider for inflation targeting. The different forms of CPI, WPI and PPI were explored in order to find which amongst them would be the best indicator of inflation in the Indian scenario.