Answer

Introduction

With India set to review its FIT framework in 2026, the headline-versus-core inflation debate has become pivotal to monetary policy design. India’s inflation dynamics are heavily influenced by food prices, demand conditions, and expectations. At the same time, FIT can be effective only when supported by fiscal discipline under the FRBM Act, which safeguards long-term macroeconomic stability.

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Why Focus on Core Inflation

• Reflects underlying demand pressures: Core inflation filters out volatile food/fuel prices, offering a clearer view of persistent inflation trends.
• Avoids reacting to supply shocks: Food inflation is often seasonal or weather-driven, beyond the RBI’s control.
• Aids forward-looking policy: Core inflation aligns better with the medium-term horizon of monetary transmission.
• Prevents policy over-tightening: It avoids excessive tightening due to short-lived spikes in headline inflation.
• Supports stable planning: Predictable core inflation helps guide savings and investment decisions.
  Eg: Food inflation in India often reflects relative price changes unless supported by expansionary demand.

Challenges with a Core-Only Approach

• Food inflation affects core prices too: Rising food prices often push up wages and production costs, eventually raising the prices of non-food items as well.
• Poor households experience headline inflation directly: Ignoring headline CPI is risky because food prices hit low-income families the hardest and shape public sentiment.
• High liquidity makes food inflation turn into general inflation: When money supply increases, even food price hikes can raise the overall price level, blurring the line between food and core inflation.
  Eg: Friedman’s argument explains how money expansion lifts general prices.
• People form inflation expectations from headline prices: The public reacts to actual price changes, especially food not to technical core inflation measures.
• India’s CPI gives heavy weight to food: Since food has a large share in the CPI basket, headline inflation better reflects real living costs and welfare concerns.

Why Monetary Policy Needs Fiscal Prudence

• Stops monetisation-driven inflation: Fiscal excess once fueled high inflation in the 1970s–80s; FRBM prevents this.
  Eg: Article cites monetised deficits as a major cause of past inflation.
• Protects RBI’s autonomy: Fiscal restraint keeps the central bank free from deficit-financing pressures.
• Keeps demand pressures in check: Fiscal slippages can nullify monetary tightening by increasing aggregate demand.
• Improves transmission: Lower borrowing needs stabilise interest rates and prevent crowding out.
• FIT and FRBM reinforce each other: Weakening either threatens overall macroeconomic stability.
  Eg: Article stresses FRBM and FIT “must go together” for sustained inflation control.

Conclusion

A balanced inflation-targeting framework must reflect India’s structural realities, where food-price movements matter and core inflation alone is inadequate. Monetary policy can be effective only when backed by fiscal discipline that avoids excess demand and preserves credibility. Strengthening both FIT and FRBM will be crucial for macroeconomic stability in the decade ahead.

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