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Flexible Inflation Targeting (FIT)

Recommended by- RBI Deputy Governor Urjit Patel

  1. In a historic monetary policy overhaul, the finance ministry and the Reserve Bank of India (RBI) have agreed to put in place a monetary policy framework to focus on flexible inflation targeting, something the central bank has been pressing for.
  2. The formalisation of the inflation targeting framework by the Reserve Bank of India (RBI) and Government of India is a big step in accepting the fact that a low and steady inflation rate is the major contribution that monetary policy can make to economic growth and macroeconomic stability.
What is Flexible inflation targeting (FIT) ?
Inflation targeting is an economic policy in which a central bank estimates or decides for a medium-term target inflation rate and makes public this "inflation target". Then the central bank attempts to steer with short-term instruments at its own discretion actual inflation towards this target through the use of interest rate changes and other monetary tools.
Because interest rates and the inflation rate tend to move in opposite directions, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting. Examples:
  • if inflation appears to be above the target, the bank is likely to raise interest rates. This usually (but not always) has the effect over time of cooling the economy and bringing down inflation.
  • if inflation appears to be below the target, the bank is likely to lower interest rates. This usually (again, not always) has the effect over time of accelerating the economy and raising inflation.

All Eyes On Target
  • Portion of monetary policy framework came into effect on February 20, 8 months after it was proposed by the FM
  • CPI inflation target for January 2016 has been set at less than 6%; 2-6% from 2016-17
  • RBI will be considered to have failed if inflation exceeds 6% for 3 consecutive quarters from 2015-16 and if it falls below 2% for 3 consecutive quarters from 2016-17
  • If RBI fails to meet targets, it will have to state the reasons for this and propose remedial action Monetary policy committee will decide on RBI’s stance.

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