MONETARY POLICY AND INFLATION TARGETING IN INDIA
CASE STUDY SOLUTION
e
pl
m
SYNOPSIS
In May 2022, India’s retail inflation rate rose above the upper limit of the target range set by the Reserve
Sa
Bank of India (RBI) in 2015, to reach 7.79 per cent.2 In recent years, India’s retail inflation rate had been
successfully kept within the target range of 2–6 per cent as the economy grew steadily. Everything changed
in March 2020, however, when the outbreak of the COVID-19 pandemic disrupted the economy of all
countries around the world. During the pandemic, government imposed lockdowns adversely impacted
n
domestic supply of essential materials and shot up price levels, leading to high inflation rates, health sector
emergencies, and loss of work for major economies across the world. In February 2022, two years after the
tio
outbreak of the pandemic, as global economies were slowly recovering from the crisis, Russia invaded
Ukraine, which further disrupted the global supply chains. As a result, all major economies had to closely
lu
So
The Case Solution Starts From page 6
,OBJECTIVES
• Understand the impact of monetary policy on economic performance for a country.
• Understand the difficulties of implementing a contractionary (or expansionary) monetary policy in an
inflationary (or deflationary) environment.
e
• Understand the interaction of monetary policy with fiscal policy and the financial markets of an economy.
•
pl
Understand the interrelationship between an economy’s money supply, unemployment, and gross
domestic product (GDP) growth in an aggregate-demand versus aggregate-supply framework.
• Understand challenges of inflation targeting in an emerging economy and how it can conflict with other
m
macroeconomic measures.
Sa
n
tio
lu
So
The Case Solution Starts From page 6
,ASSIGNMENT QUESTIONS
1. What challenges does a growing economy with a large informal sector present for monetary authorities?
e
2. How does contractionary or expansionary monetary policy impact GDP growth? What are India’s
experiences over previous four decades?
pl
3. What is inflation targeting and what are its alternatives?
4. Does inflation targeting compromise the objective of increasing employment for a growing economy
m
like India?
5. Should the RBI governor reduce the repo rate by 25 basis points? Should he apply quantitative
Sa
tightening to contain inflation? What are the implications of such policy intervention for the economy?
6. Is inflation targeting a sustainable strategy for monetary authorities in India with high
underemployment and a depreciating domestic currency?
n
tio
lu
So
The Case Solution Starts From page 6
,2. How does contractionary or expansionary monetary policy impact GDP growth? What are
India’s experiences over previous four decades? (10 minutes)
To explain expansionary monetary policy, refer students to the growth in the supply of Broad
Money, or M3, since the 1980s (see case Exhibit 2), in contrast to GDP growth (see case Exhibit 1).
integrate in the conversation the role of inflation in the expansion of economic activities, especially
WPI inflation, highlighting the slow pace of growth in India’s economy until the 1980s.
introduce the concept of “Hindu Rate of Growth,” which was coined by economist Raj Krishna in 1978.3 Since
1991, a faster growth of money supply has been shown to be instrumental in registering a higher GDP growth
rate, along with lower levels of unemployment. The slow growth rate during the period of 1980–1991 was in
contrast to the higher growth rate during the period of 1991–2000 and in subsequent decades, when M3 and
GDP rates were growing while unemployment was dropping (see Exhibit TN-1).
ask students what led to higher GDP growth after India started economic liberalization
in 1991. Student responses should include the following factors:
e
• Stable inflation rate, robust money supply, and clarity in policy rates
pl
• Integration of Indian markets with global economy
• Cost competitiveness due to globalization and liberalization of trade policies
m
• Emergence and growth in the information technology sector and India’s contribution to the global
technology revolution of the 1990s
Sa
• Employment opportunities that led to the expansion of the economy and higher growth
• Rise in real wages experienced by Indian workers after the start of liberalization
India joined the world economy and reaped the benefits of a globalized economy with an enhanced GDP
n
growth rate, a larger share of trade, greater foreign exchange reserves, and integration with the global
economy to create opportunities for all the stakeholders. The instructor can underline the importance of a
tio
supportive robust monetary policy, which helped India’s transition from levels of subsistence to levels of
surpluses on all economic fronts after 1991.
lu
So
The Case Solution Starts From page 6
,
2,000
4,000
6,000
8,000
0
10,000
12,000
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
So
1998-99
1999-00
lu
2000-01
2001-02
GDP
2002-03
tio
2003-04
2004-05
n 2005-06
2006-07
Inflation
2007-08
2008-09
2009-10
Sa
2010-11
M3
m
2011-12
2012-13
2013-14
2014-15
The Case Solution Starts From page 6
pl
2015-16
2016-17
e
2017-18
EXHIBIT -1: MONEY SUPPLY, GDP, AND INFLATION IN INDIA (1991–2021)
2018-19
2019-20
2020-21
CASE STUDY SOLUTION
e
pl
m
SYNOPSIS
In May 2022, India’s retail inflation rate rose above the upper limit of the target range set by the Reserve
Sa
Bank of India (RBI) in 2015, to reach 7.79 per cent.2 In recent years, India’s retail inflation rate had been
successfully kept within the target range of 2–6 per cent as the economy grew steadily. Everything changed
in March 2020, however, when the outbreak of the COVID-19 pandemic disrupted the economy of all
countries around the world. During the pandemic, government imposed lockdowns adversely impacted
n
domestic supply of essential materials and shot up price levels, leading to high inflation rates, health sector
emergencies, and loss of work for major economies across the world. In February 2022, two years after the
tio
outbreak of the pandemic, as global economies were slowly recovering from the crisis, Russia invaded
Ukraine, which further disrupted the global supply chains. As a result, all major economies had to closely
lu
So
The Case Solution Starts From page 6
,OBJECTIVES
• Understand the impact of monetary policy on economic performance for a country.
• Understand the difficulties of implementing a contractionary (or expansionary) monetary policy in an
inflationary (or deflationary) environment.
e
• Understand the interaction of monetary policy with fiscal policy and the financial markets of an economy.
•
pl
Understand the interrelationship between an economy’s money supply, unemployment, and gross
domestic product (GDP) growth in an aggregate-demand versus aggregate-supply framework.
• Understand challenges of inflation targeting in an emerging economy and how it can conflict with other
m
macroeconomic measures.
Sa
n
tio
lu
So
The Case Solution Starts From page 6
,ASSIGNMENT QUESTIONS
1. What challenges does a growing economy with a large informal sector present for monetary authorities?
e
2. How does contractionary or expansionary monetary policy impact GDP growth? What are India’s
experiences over previous four decades?
pl
3. What is inflation targeting and what are its alternatives?
4. Does inflation targeting compromise the objective of increasing employment for a growing economy
m
like India?
5. Should the RBI governor reduce the repo rate by 25 basis points? Should he apply quantitative
Sa
tightening to contain inflation? What are the implications of such policy intervention for the economy?
6. Is inflation targeting a sustainable strategy for monetary authorities in India with high
underemployment and a depreciating domestic currency?
n
tio
lu
So
The Case Solution Starts From page 6
,2. How does contractionary or expansionary monetary policy impact GDP growth? What are
India’s experiences over previous four decades? (10 minutes)
To explain expansionary monetary policy, refer students to the growth in the supply of Broad
Money, or M3, since the 1980s (see case Exhibit 2), in contrast to GDP growth (see case Exhibit 1).
integrate in the conversation the role of inflation in the expansion of economic activities, especially
WPI inflation, highlighting the slow pace of growth in India’s economy until the 1980s.
introduce the concept of “Hindu Rate of Growth,” which was coined by economist Raj Krishna in 1978.3 Since
1991, a faster growth of money supply has been shown to be instrumental in registering a higher GDP growth
rate, along with lower levels of unemployment. The slow growth rate during the period of 1980–1991 was in
contrast to the higher growth rate during the period of 1991–2000 and in subsequent decades, when M3 and
GDP rates were growing while unemployment was dropping (see Exhibit TN-1).
ask students what led to higher GDP growth after India started economic liberalization
in 1991. Student responses should include the following factors:
e
• Stable inflation rate, robust money supply, and clarity in policy rates
pl
• Integration of Indian markets with global economy
• Cost competitiveness due to globalization and liberalization of trade policies
m
• Emergence and growth in the information technology sector and India’s contribution to the global
technology revolution of the 1990s
Sa
• Employment opportunities that led to the expansion of the economy and higher growth
• Rise in real wages experienced by Indian workers after the start of liberalization
India joined the world economy and reaped the benefits of a globalized economy with an enhanced GDP
n
growth rate, a larger share of trade, greater foreign exchange reserves, and integration with the global
economy to create opportunities for all the stakeholders. The instructor can underline the importance of a
tio
supportive robust monetary policy, which helped India’s transition from levels of subsistence to levels of
surpluses on all economic fronts after 1991.
lu
So
The Case Solution Starts From page 6
,
2,000
4,000
6,000
8,000
0
10,000
12,000
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
So
1998-99
1999-00
lu
2000-01
2001-02
GDP
2002-03
tio
2003-04
2004-05
n 2005-06
2006-07
Inflation
2007-08
2008-09
2009-10
Sa
2010-11
M3
m
2011-12
2012-13
2013-14
2014-15
The Case Solution Starts From page 6
pl
2015-16
2016-17
e
2017-18
EXHIBIT -1: MONEY SUPPLY, GDP, AND INFLATION IN INDIA (1991–2021)
2018-19
2019-20
2020-21
