Inflation targeting is a practice whereby t the central bank of the country commits to keep the inflation within some desirable/reasonable limit as fixed by it. In the recent past, several countries have been opting for inflation targeting as a monetary policy objective due to the following reasons:

• Helps in long-term planning for public and private entities and in policy formulation.
• Redistributes income and wealth between different groups in the society. High inflation benefits some groups at the expense of others. Provides a climate of certainty and thus boosts lender confidence, as high inflation implicitly penalizes the lender. Inflation targeting requires the following:
• The ability of the central bank to conduct monetary policy with some degree of independence. Fiscal policy considerations cannot dictate monetary policy alone.
• The second requirement is the willingness and ability of the monetary authorities not to target other indicators, such as wages, the level of employment, or the exchange rate. The Inflation targeting framework in India was initiated through the Inflation targeting agreement of 2015 which further culminated in the Amendment of the RBI Act in 2016.
• The Act adopted year-on-year changes in the headline Consumer Price Index (CPI) as the measure of inflation target. The target was fixed at 4% with an upper and lower tolerance band of 2%.
• The Act has mandated the following working methodology for the Monetary Policy Committee (MPC):
  • The decisions by the MPC are decided by a majority of votes by the members present and voting, and in the event of an equality of votes, the Governor has a second or casting vote.
  • The resolution adopted by the Monetary Policy Committee must be published after the meeting of the MPC.
  • The RBI must publish a report on monetary policy twice a year. The report should outline the sources of inflation and short-medium-term forecasts of inflation.
  • In the event of failure to achieve the inflation target, the Act lays down that the RBI will inform the Central Government of the following: ✓ The reasons for failure to achieve the inflation target. ✓ The remedial actions it proposes to take. ✓ An estimate of the time within which the inflation target shall be achieved after the implementation of the remedial actions.

It needs to be kept in mind that there is a built-in “escape clause” in the monetary policy that permits inflation to rise above the mandated target. The RBI during the ongoing pandemic has resorted to its use to keep interest rates low.