Monetary Policy Framework Agreement (MPFA)
The Monetary Policy Framework Agreement (MPFA) was adopted in 2015 and incorporated into the Reserve Bank of India Act, 1934 in May 2016. The main features of the MPFA are:
The prime objective of monetary policy is to "maintain price stability, keeping in mind the objective of growth." This means that the primary goal of monetary policy is to maintain price stability, while also taking into account the need for economic growth.
The inflation target is to be fixed by the government of India in consultation with the RBI every 5 years. The current inflation target is 4% +/- 2%, which was set for the period 2016-2021.
The Monetary Policy Committee (MPC) is responsible for fixing the policy interest rate in order to achieve the inflation target.
The RBI is required to publish a Monetary Policy Report at half-yearly intervals, which should highlight the sources of inflation and provide a forecast of inflation for the next 6-18 months.
If the CPI-Inflation remains below 2% or above 6% for three consecutive quarters, the RBI will be deemed to have failed in achieving the inflation target. In such a case, the RBI is required to submit a report to the government of India.
Inflation targeting
Under inflation targeting, the priority is given to controlling inflation over other objectives. Some advantages of inflation targeting include:
Increased accountability: Inflation targeting helps to increase the accountability of the central bank by quantitatively expressing the objective of monetary policy. This can make it easier to hold the central bank accountable for its actions and decisions.
Increased sensitivity to inflation: Inflation targeting can help to increase the sensitivity of the government or central bank towards controlling inflation. This can be especially important in situations where inflation is high or rising, as it can help to ensure that appropriate policy measures are taken to address the issue.
Decreased scope for conflict: Inflation targeting can help to decrease the scope for conflict between the central bank and the government. This is because both parties are working towards the same goal of controlling inflation, which can help to reduce tension and improve coordination.
However, inflation targeting may not be desirable in developing countries for a number of reasons. For example, in developing countries, inflation is often caused by supply-side factors that cannot be addressed through monetary policy. In such cases, using monetary policy to control inflation could have severe repercussions on economic growth. Additionally, developing countries may have less developed financial markets, which can make it more difficult to implement inflation targeting effectively.
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