Indian Industrial Pricing Under Flexible Inflation Targeting

Abstract

A puzzling characteristic of post-pandemic Indian inflation is the fall, within 10 years of adopting flexible inflation targeting (FIT), in core inflation to lifetime lows despite high growth and recurrent commodity price shocks. Establishing the credibility of FIT is expected to take time in emerging markets (EMs) since prerequisites are thought to include independent central banks (CBs) that focus only on inflation, giving up other types of intervention. The Indian CB, however, continued foreign exchange intervention and its coordination with the government improved over the period. Even so, our evidence from multiple exercises with a disaggregated industry panel suggests firms’ pass-through of supply shocks reduced in the FIT period. The results support the effectiveness of the communications and expectations channel in EMs compared to other channels. EM features imply prerequisites for successful FIT may not be the traditional ones. Flexible, not strict, inflation targeting, with procedures adapted to the context, can reduce growth sacrifice while lowering inflation.

JEL Classification: E31, E32

Keywords

Inflation targeting firms’ price-setting supply shocks expectations channel

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