The Flexible Inflation Targeting (FIT) framework, which mandates RBI to maintain inflation at 4% ± 2%, is set to expire in March 2026 and is currently under review. 

Key Issues Under Review in India’s Inflation Targeting Framework

• Headline vs Core Inflation: 
  • Why Target Headline Inflation: It better protects savings, investment decisions, and vulnerable households from broad price shocks.
  • Food Inflation Not Only Supply-Driven: Evidence shows expansionary monetary policy can amplify food prices, while contractionary policy moderates them.
  • Relative Prices vs General Price Level: Item-specific price changes affect relative prices, but sustained inflation reflects expansion in money supply.
  • Second-Round Effects: Food inflation spills into core inflation through wage pressures and input-cost channels.
  • Food Inflation and Demand: With rising aggregate demand, food inflation can raise the general price level, requiring monetary policy to include food prices.
• Determining the Acceptable Level of Inflation:
  • Weak Phillips Curve in India: The inflation–growth trade-off is weak; any trade-off exists only in the short run.
  • Threshold Inflation: Growth declines once inflation crosses a threshold, showing a non-linear inflation–growth relationship.
  • Empirical Estimate for India: Post-1991 data show an inflection point at about 3.98 percent, placing acceptable inflation near 4 percent.
• Inflation Band: 
  • Adequacy of the Current Band: The current ±2% band has offered sufficient flexibility for monetary policy implementation.
  • Growth Risks Beyond 6% Inflation: Empirical data show that growth declines sharply once inflation rises beyond 6%.

Fiscal Policy and Price Stability

• Historical Lessons: High inflation in the 1970s–80s came from automatic monetisation of fiscal deficits, leading to the end of ad hoc Treasury Bills.
• FRBM as Foundation for FIT: The Fiscal Responsibility and Budget Management Act institutionalised fiscal discipline and enabled Flexible Inflation Targeting (FIT).
• Mutual Dependence of FRBM and FIT: Fiscal discipline and monetary discipline reinforce each other; slippage in either undermines macroeconomic stability.

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Conclusion

A stable inflation framework for India ultimately depends on targeting headline inflation and maintaining strong fiscal discipline.

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