(The authors are, respectively, with the Indira Gandhi Institute of Development Research and Federal Reserve Bank of Boston. The views expressed in this article are solely those of the authors and should not be reported as representing the views of the Federal Reserve Bank of Boston, the principals of the Board of Governors, or the Federal Reserve System.)
Next year a critical policy review looms for the Indian government: Whether to retain or revise the inflation-targeting framework, a cornerstone of India’s monetary policy for a decade. Critics have been pushing for major changes — ranging from tweaking the target number to redefining the target variable, or even shifting the Reserve Bank of India’s (RBI’s) core mandate. However, a major revision now would be unwise because evidence shows that the framework has delivered.
India's formal adoption of inflation targeting in 2016 marked a fundamental shift in the way monetary policy was conducted. Until then, the RBI had been juggling several goals — rapid economic growth, adequate credit flow, and a stable exchange rate. This left its primary responsibility of controlling inflation somewhat diffused. The 2016 reform fixed that by giving the RBI a single, clear mandate: Keep the inflation rate based on the consumer price index (CPI) at 4 per cent, give or take 2 percentage points. This framework made the central bank’s objective both clearer and easier to evaluate.
That said, lower inflation by itself does not prove that the framework has succeeded. Prices can fall for reasons that have nothing to do with monetary policy — like a global drop in commodity prices or strong agricultural output. In fact, studies show that such favourable shocks played a big role in bringing the inflation rate down soon after the framework was introduced. Critics point to this and argue that the success in this respect was driven more by good luck than by sound policy.
But this argument overlooks the real test, which came later. Between 2022 and 2024, global energy and food prices spiked after war in Ukraine started. In India, the food inflation rate averaged about 7 per cent. Yet, barring a few months, the overall inflation rate stayed within the target band for most of this period. This was a sharp contrast to the pre-framework years, when similar shocks routinely pushed the inflation rate into double digits. This stability suggests that something deeper than good luck is at work: The RBI has built credibility.
Credibility is at the heart of any inflation-targeting regime. It captures the public’s confidence that the central bank will follow through on its commitment to keep prices in check. When households and firms trust the RBI, temporary supply shocks, such as spikes in food or fuel prices, do not immediately feed into long-term inflation expectations. In other words, expectations stay anchored. And once expectations are anchored, inflation itself becomes easier to manage because firms are less likely to raise other prices in response to a shock, and workers are less likely to demand higher wages.
This sets off a virtuous cycle. Credibility keeps expectations anchored, stable expectations help keep prices low, and low inflation in turn strengthens credibility.
There are signs that this cycle is beginning to take hold in India. Surveys show that while people still expect the inflation rate to be higher than the 4 per cent target, their expectations fluctuate far less than they once did. Research by RBI economists Sitikantha Pattnaik, G V Nadhanael, and Silu Muduli (2023) finds that households’ inflation expectations have become less sensitive to short-term price movements — another indication that expectations are gradually becoming more anchored.
Studies of professional forecasters show the same pattern. Research by Bhanu Pratap and Kundan Kishor (2023) and by IMF (International Monetary Fund) economists Patrick Blagrave and Weicheng Lian (2020) finds that medium-term inflation forecasts have become more stable and less sensitive to short-term inflation surprises. In our own research (Vaishali Garga, Aeimit Lakdawal Lakdawala and Rajeswari Sengupta, 2022), we find that professional forecasters now expect the RBI to react more strongly to rising inflation than it did before the inflation-targeting regime. Their expectations have also become less responsive to shocks in oil prices. Together, this evidence suggests that India's recent inflation stability is not just the result of favourable global factors. It reflects a steady buildup of policy credibility.
In this context, making major changes to the framework would be risky because it could undermine the credibility that has been built since 2016. This does not mean the framework cannot be improved. Rather, any changes should focus on better data, greater transparency, and clearer communication — not on rewriting the core rules. Two areas for improvement stand out.
First, the RBI's survey of household inflation expectations needs a major upgrade. At present, it asks people mainly about expected price changes over the next three months or one year. The survey should be redesigned to capture households’ longer-term inflation expectations more effectively. This would offer far more useful insights for policy because decisions about saving, investing, or negotiating salaries depend on how people expect inflation to evolve over several years — not just in the near term.
Second, policymakers need better information on what businesses expect. Since firms are the ones that set prices and wages, their view of future inflation is crucial. Yet India currently lacks systematic data on firms’ inflation expectations. The RBI could address this gap by regularly surveying firms and publishing the results. This would help the central bank judge whether price pressures are becoming entrenched and enable it to respond more effectively.
The next decade will bring fresh challenges — climate-related supply shocks, volatile energy prices, and global financial uncertainties. The best way for India to prepare is by preserving and strengthening the RBI’s hard-won credibility. If, instead, the framework is rewritten and trust in monetary policy is weakened, rebuilding that credibility could take another decade or more.
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