Structural Limitations of Inflation Targeting in India

Gist The Reserve Bank of India recently completed a decade of its formal Inflation Targeting IT framework, prompting critical macroeconomic scrutiny of its efficacy. Recent academic analysis indicates that the underlying mechanism of this framework—the New Keynesian Phillips Curve—is functionally flat in the Indian context. Consequently, utilizing interest rate hikes to combat inflation in India risks suppressing economic output and employment without delivering a commensurate reduction in prices, a structural mismatch aspirants must understand when evaluating RBI policy. Background The Flexible Inflation Targeting FIT framework was formally adopted in India following amendments to the Reserve Bank of India Act, 1934 . It mandates the RBI to maintain consumer price inflation at 4% , within a tolerance band of +/- 2% , while keeping the objective of growth in mind. Theoretically, the central bank achieves this by manipulating the repo rate to control aggregate demand and by anchoring public inflation expectations. This dual mechanism relies heavily on the New Keynesian Phillips Curve NKPC , a macroeconomic concept that posits a direct relationship between economic output and inflation. The model assumes that…