A Theory of Growth and Threshold Inflation with Estimates
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A Theory of Growth and Threshold Inflation with Estimates Ravindra H. Dholakia1
© The Indian Econometric Society 2020
Abstract For an inflation targeting Central Bank, a precise estimate of the threshold inflation in the economy is important. Existing studies provide estimates without any coherent theory of growth and threshold inflation and hence suffer from several limitations about concept and measurement. The present paper attempts to develop such a theory to establish a stable steady state growth solution. It also operationalizes the theory through a model with support from the Indian data for specific components of the model to derive the required functional form. Final estimates in India with annual data from 1995–96 to 2017–18 show that the threshold inflation and associated optimal growth vary considerably as rates of fiscal deficit and current account deficit on the balance of payments vary. The current combinations of the long term four policy targets of 4% inflation; 8% growth; 6% fiscal deficit (to GDP); and 2% current account deficit (to GDP) are internally inconsistent and hence not achievable. Now that there is an opportunity to revise the inflation target for the period after March 2021, the present paper argues for choosing from the menu of internally consistent options for all these four policy targets to avoid unnecessary costs. Keywords Inflation targeting · Macroeconomic policy · Inflation growth · Optimal growth models · Multiple equation models · Threshold inflation
This is the Presidential Address by Prof. Ravindra H. Dholakia at the 56th Annual Conference of The Indian Econometric Society (TIES) at Department of Economics, Madurai Kamaraj University, Madurai on January 8–10, 2020. My Co-authors - Dr. Jai Chander, Mr. Bhanu Pratap, Ms. Ipsita Padhi and Dr. Sanjib Bordoloi of RBI have contributed in major part of the literature review and data work including running regressions. * Ravindra H. Dholakia [email protected] 1
Monetary Policy Committee, Reserve Bank of India (RBI), Mumbai, India
13
Vol.:(0123456789)
Journal of Quantitative Economics
Context and Relevance The Amendment of the RBI Act to introduce Flexible Inflation Targeting framework with an independent Monetary Policy Committee (MPC) in 2016 was considered as the second most important economic reform for upgrading India’s investment rating by the international rating agencies. It was hoped that this reform would ensure price stability and benefit the economy by attracting investors from all over. The term of the first MPC is for 4 years up to September 2020 and the inflation target is set for 5 years up to March 2021. If we simply consider the price stability in terms of achieving the given inflation target of 4%, the performance of the MPC may be considered reasonably good. However, in terms of attracting investors from all over, it is far from satisfactory. Thus, this is the right time to start the process of critically examining the flexible inflation targeting framework of the monetary policy in the country a
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