Lower Inflation Target: Growth may hurt, but will bring financial stability: RBI study

A Reserve Bank of India (RBI) research has suggested a decision to have a lower inflation target would put at risk the long-term growth but help in bringing in financial stability. "The policymakers 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 favorable redistribution effects particularly on the poor and is beneficial for financial stability," it said. 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.

"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,” it said.

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