India cannot risk another bout of inflation, Reserve Bank of India Governor Shaktikanta Das said on his rationale to hold interest rates at this month’s Monetary Policy Committee (MPC) meet.
Inflation
Inflation refers to the consistent rise in the prices of goods and services in an economy, measured on a year-on-year basis.
For example: 6% inflation in April 2024 means prices rose by 6% compared to April 2023. It is calculated as:
Rate of Inflation = [(Current Period Price – Previous Period Price) ÷ Previous Period Price] × 100
Inflation is measured using the Price Index and can be categorized based on rate and causes.
Types of Inflation Based on rate:
- Creeping Inflation (2-3%): Slow, manageable rise that encourages economic growth.
- Walking Inflation (3-10%): Faster rise; a warning signal for potential higher inflation.
- Galloping Inflation (10-50%): High rate where incomes and investments fail to keep pace.
- Hyperinflation (>50% per month): Extreme, rapid increase in prices that severely devalues currency, as seen in Zimbabwe (2004-09) and Venezuela (2019).
Types of Inflation Based on Causes
- Demand-Pull Inflation: Caused by a rise in aggregate demand, often due to increased disposable income, leading to higher prices as supply fails to meet growing demand.
- Cost-Push Inflation: Results from increased production costs (e.g., higher wages or material costs), raising the overall cost of goods and services.
- Supply-Shock Inflation: Triggered by sudden, unexpected drops in supply (e.g., natural disasters), leading to sharp price increases.
- Structural/Bottleneck Inflation: Arises from economic inefficiencies like poor infrastructure or low productivity, creating supply shortages and driving up prices.
- Protein Inflation: Driven by shifts in dietary preferences towards protein-rich foods (e.g., milk, meat), leading to higher demand and prices.
Monetary Policy
- Definition: The central bank’s policy for using monetary instruments to achieve specified economic goals.
- Primary Objective: To maintain price stability while supporting economic growth.
- Importance of Price Stability: It is essential for achieving sustainable growth.
- Inflation Target: As per the amended RBI Act, 1934, the inflation target is set at 4% (±2%).
- Review of Inflation Target: The Government of India, in consultation with the Reserve Bank, revises the target once every five years.
Monetary Policy Committee (MPC)
- Origin: Established under Section 45ZB of the amended RBI Act, 1934 (in 2016). The central government is authorized to constitute the MPC.
- Objective: The MPC determines the policy rate to achieve the inflation target, as specified in Section 45ZB. Its decisions are binding on the RBI.
- Composition:
- Total of six members:
- RBI Governor (ex-officio chairperson)
- Deputy Governor in charge of monetary policy
- One officer nominated by the RBI’s Central Board
- Three members appointed by the central government, chosen for their expertise in economics, banking, finance, or monetary policy.
Inflation, if left unchecked, can lead to a range of economic challenges, from reduced purchasing power to strained investments. By adhering to its inflation target of 4% (±2%), the RBI strives to ensure that India maintains a stable economic environment conducive to growth. The role of the MPC is critical in this process, as it makes decisions regarding the policy rate to steer inflation toward the target.
