Don’t ignore the likely cost of lower inflation: RBI study

When inflation is above the threshold level, estimated at 6% for India, the reduction in the inflation rate results in a much smaller gain in long-term growth than when inflation is lower and rises towards the bottom. threshold level, according to a reserve Study of the Bank of India.

The study estimated the trade-off between long-term inflation and the steady-state growth rate (SSG), long-term growth would fall by 40 basis points / bp (or 0.4 percentage point) if the initial inflation rate was below the rate threshold.

However, if the initial inflation rate were above the cut-off rate, the result would be an increase in long-term growth of 15 bps.

“… Of course, there are arguments for lowering the inflation rate in terms of its favorable redistributive impact especially on the poor and financial stability issues,” said the authors Ravindra H Dholakia, Jai Chander, Ipsita Padhi and Bhanu Pratap.

However, the results of this study caution policymakers not to ignore the likely cost of lower inflation in terms of lower long-term growth in output and employment and hence a lower rate. lower poverty reduction.

These costs and benefits of setting a long-term inflation target will need to be considered when choosing, the authors argued.

The results of the Development Research Group (DRG) study show that the inflation threshold and the corresponding growth are not unique for a country but depend on the other two parameters – budget deficit (FD) / GDP and current account deficit. (CAD) / GDP.

If a country chooses the FD / GDP and CAD / GDP target values ​​to be achieved in the long run, its growth in potential output is determined by the corresponding value of the inflation threshold.

“If the country then chooses an inflation target below the threshold level, it cannot meet its potential output growth and the system would remain in imbalance in the long run requiring constant policy interventions to stabilize,” the authors said. .

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