Central banks may need greater flexibility in targeting inflation

livemint.com:

India’s latest inflation number at 7.4% comes as a shocker, with doom-speak all around. This is so because we have been talking of getting to 4%, which was axiomatically taken to be the ideal mark. This is analogous to the US, which has a target of 2%.

But we need to pause and reflect on two counts. The first is that inflation will always surface at higher than accepted levels periodically across the world and there are no quick fixes. If governments and central banks can bring inflation rates down to their targets with ease, then price stability would reign.

The fact that all governments and central banks struggle means that authorities can at best try and make a difference at the margin, but are ineffective beyond a point. Rates are raised to plug away at the demand side. This cannot be done in one stroke, so policy interest rates that need to rise by 300 basis points, say, are pushed up in smaller-sized hikes spaced out across time.

But what of the supply side? At the policy level, the government can make changes in the foreign trade rules of engagement. The exports of sensitive items like foodgrains can be banned, for example, which is not good for globalization but serves domestic interests. Imports can be used to fill supply shortfalls, but once prices go up, it is hard to ensure that these imports reach far and wide enough to soften them adequately.

At another level, stock limits could be imposed to prevent hoarding, but if this is not a cause of rising prices, then it only creates panic and has self-fulfilling effects. This is what we have witnessed in India recently. Buying food products at a higher cost and selling cheap, as was done for tomatoes by New Delhi, is not sustainable beyond a month or so and cannot