desire to reduce the output gap would reduce it by 0.6 percentage points. Combine the three ingredients, and the final rate - based on historical trends - should be 8.7 percent for the third quarter of 2013.
But following Rajan's intervention, the actual rate was 9.5 percent on Sept. 25. Since Rajan's actions suggest he cares less about the value of the rupee and lost output, the higher observed rate points to one explanation: banks believe the new governor is putting a greater emphasis on controlling inflation than before.
This new rule, if Rajan can make it credible, could lead India to embrace a formal inflation-targeting regime. But it shouldn't be in a hurry to go down that route. Since the 1997 financial crisis, most developing countries in Asia have adopted arrangements whereby the central bank is given an inflation goal by the government or parliament, and told to focus its efforts on achieving it. By and large, inflation targeting has worked -- but not everywhere, and not always. For example, the Bank of Thailand steadily raised interest rates in 2006 in an attempt to rein in inflation. The hot money that poured eventually prompted the country to impose capital controls. Thai assets were subsequently walloped.
Before India can migrate to inflation targeting, the government must first prune its permanently elevated budget deficit, so that it's able to use fiscal policy to dial economic output up and down. Still, there is no doubt that too many ingredients are spoiling the consistency of India's monetary broth. Even if Rajan can't adopt a simpler recipe overnight, he can enhance the anti-inflation flavour of his interest-rate concoction.
The author is a columinst currently writing for Reuters' Breakingviews