1. However, we believe, inflation targeting per se in a country like India will face some key operational challenges as it will require close co-ordination with the Government.
2. This apart, aftermath the financial crisis, there are now renewed thoughts regarding the efficacy of a blanket inflation targeting. For example, in US, Fed has recently adopted unemployment as secondary objective underlying the concerns to growing unemployment situation. In a similar vein, Bank of England had most recently advocated use of a nominal GDP as a target.
3. This apart, the evidence of successful inflation targeting in advanced and particularly emerging economies are also not exactly conclusive, in terms of a trade-off between social costs of inflation vis--vis increased cost of possible deflation.
4. The choice of CPI as a nominal anchor in Western and even emerging economies is also guided by different rational - high household indebtedness - a phenomenon absent in India. Interestingly, mortgage interest payments are included in CPI basket in countries like UK, to make the transmission impact more effective.
5. Furthermore, we also believe that the composition of MPC should be more broad-based, with even representation of the Government (akin to UK) to have better monetary and fiscal policy interlinkage.
6. We also believe that in an emerging economy like India, an exact application of loanable fund theory (savings as a function of interest rate) may not fully apply.
7. Our analysis shows that in the second half of 2000 there was a perceptible influence of changes in national income in influencing aggregate level of savings during that period. If that is the case, the central bank may not be unduly bothered in monetary policy having a specific positive real policy rate anchor. This is an inevitable consequence in the current slowdown phase. On the whole, we now believe that there is a larger probability of interest rates staying at elevated levels for an extended period following the committee report.
Outlook on rates: We continue to maintain that rates will be on hold on 28 Jan14 policy.
By Dr. Soumya Kanti Ghosh, Chief Economic Adviser, Economic Research Department, State Bank of India.