WHY FOOD PRICES SHOULD INFORM THE INFLATION FIGHT

tHE debate over whether or not inflationary shocks on account of food should fall within the scope of monetary policy is not new.

Former Reserve Bank Governor Raghuram Rajan addressed this issue in a speech in 2014, noting, "They say the real problem is food inflation, how do you expect to bring it down through the policy rate?" Rajan's remarks highlighted the persistent challenge central banks face in balancing the need for price stability with the complexities of food-driven inflation, often beyond the immediate influence of monetary policy.

The topic resurfaced in the latest Economic Survey when the chief economist to the Centre, in the chapter 'Medium-term outlook: A growth vision for new India', called for re-examining the RBI's inflation-targeting framework, suggesting food be excluded.

The chief economist argued food inflation is largely driven by supply-side factors such as the unpredictability of monsoons, crop failures, and government-set minimum support prices. The RBI's monetary policy tools, designed to combat inflationary pressures stemming from excess aggregate demand, may prove counterproductive in addressing supply-driven inflation.

However, RBI authors Michael Debabrata Patra, Joice John and Asish Thomas George, in the latest RBI Bulletin released on August 19, have countered this. They demonstrate that food inflation significantly and positively influences inflationary expectations. As inflationary expectations drift away from the central bank's target and become "unanchored", they undermine the effectiveness of monetary policy.