Financial stability taken care of under flexible inflation targeting regime: RBI research

The present flexible inflation targeting (FIT) regime in India envisages policy action to ensure price stability, ‘while being mindful of the growth objective’. “The empirical results show that through a proper co-ordination between monetary and macroprudential policies, the financial stability goals are implicitly met under the FIT regime without diluting the inflation targeting objective” said a research paper by RBI economists in the latest monthly bulletin.

Empirical literature is divided on whether financial stability should be adopted by an inflation targeting central bank as an explicit policy objective. While there are a number of arguments on both sides, cross-country evidence suggests that there are only a few inflation-targeting central banks committing to such an explicit target, although all of them strive to achieve the financial stability goal. At present, Australia, Brazil, England, Japan and South Africa are FIT Countries with Financial Stability as central bank mandate.

Constructing an index of macroprudential measures, evidence presented in this article suggests that macroprudential measures taken by the Reserve Bank were effective in restraining excessive credit growth during 2004-2011. At the same time, it has not demonstrated any major conflict between stance on financial stability, price stability and growth objective so far.

An econometric analysis by the authors suggests that while monetary policy has been most effective in containing inflation risks, macroprudential policies were effectively deployed to contain financial stability concerns. Since their inception in early 2000s in India, macroprudential policies have generally complemented monetary policy and it is important to continue with the same approach.

Financial stability is an implicit goal of the central bank, which uses the benefits of interaction between the monetary and macroprudential policies conducted under one roof. Setting a financial stability objective for monetary policy, on top of already existing price and growth considerations, may be akin to going back to the earlier multiple indicators approach, which may seriously affect the price stability objective. It is, therefore, important to continue with the existing framework, the paper concludes.