Lower inflation target to hurt growth, but will bring financial stability: RBI study

Mumbai, May 25: A Reserve Bank of India (RBI) study has suggested a decision to have a lower inflation target would jeopardise the long-term growth but help in bringing in financial stability.

“The policy makers may choose to set the inflation target below the threshold level, but only by consciously sacrificing long-term real growth of GDP and hence the adverse impact on the rate of poverty alleviation,” said the study titled ‘Threshold Level of Inflation – Concept and Measurement’

“On the other hand, lower inflation has favourable redistribution effects particularly on the poor and is beneficial for financial stability,” it said.

The report has been co-authored by Ravindra H. Dholakia, Jai Chander, Ipsita Padhi and Bhanu Pratap.

Empirical findings of the study broadly confirm higher threshold inflation and higher growth in the emerging market economies than in the advanced economies. From the cross-country panel data, the study also derives estimates of the threshold inflation for India by introducing country specific intercept and selected slope dummies.

It also provides estimates of the trade-off between long run inflation and SSG rate – 40bps of loss in growth per 100bps reduction in inflation from the threshold level; and 15bps of gain in the growth for 100bps reduction in inflation towards the threshold level.

“An important finding of the present study is that the trade-off between long run equilibrium inflation and SSG is not symmetric around the threshold inflation. When the inflation is higher than the threshold level, reduction in inflation rate leads to a much smaller gain in the long-term growth compared to when inflation is lower and rises towards the threshold level,” said the study.

Such long run trade-off along with the short to medium run sacrifice ratios for the country should be used for considering costs and benefits of setting inflation target in the country, it added.