Inflation Targeting Has Cost India Jobs Without Controlling Prices

Inflation Targeting Has Cost India Jobs Without Controlling Prices

India's inflation-targeting framework rests on a specific economic story: raise interest rates, cool demand and either output falls along with inflation or people's expectations of future inflation fall instead, sparing output the pain. A decade of data suggests neither version of that story is actually happening here.

THE REASONING

Inflation targeting works, in theory, through the New Keynesian Phillips Curve - the idea that when the economy runs hot, tight labour markets let workers bargain up wages, which businesses then pass on as higher prices.

Raise interest rates, cool demand and that wage-price spiral eases. But that entire mechanism depends on workers actually having bargaining power to negotiate wages up in the first place. In India, roughly 92 percent of the workforce is informal, meaning the overwhelming majority of workers are price-takers with no meaningful ability to negotiate wages regardless of how hot the economy runs.

Strip out that bargaining power and the wage-price link the whole framework depends on simply isn't there - which is exactly what Azad and Chowdhury's decade-long empirical test of India's Phillips curve finds: it's flat.

Raising rates cools demand and output, but with no functioning wage-bargaining channel to transmit that cooling into lower prices, inflation doesn't meaningfully fall - only growth and jobs do.

THE STRONGEST COUNTER-ARGUMENT

The strongest defence of inflation targeting doesn't rely on the wage-bargaining channel at all - it rests on expectations management. Even if the Phillips curve is flat, proponents argue, a credible inflation target can still work by anchoring what people expect prices to do next, which itself feeds into pricing and wage decisions independent of labour-market tightness.

On this view, the RBI doesn't need workers to bargain wages up or down; it just needs households and businesses to trust that the RBI will hit its 4 percent target and that trust alone does the disciplining work. This is a real mechanism, not a manufactured one - central banks worldwide have used credible targets to anchor expectations even in economies with weak formal wage bargaining.

WHY THE POSITION STILL HOLDS

The problem is that this exact mechanism is the one the data shows has also failed. If expectations management were working, household inflation expectations should track the RBI's own projections reasonably closely. Instead, the RBI's own Inflation Expectations Survey of Households shows expectations have run about four percentage points above the RBI's projections, consistently, over the decade studied - and the gap holds even when compared against actual realised inflation, not just the RBI's forecasts.

That is not a minor miss; it is direct evidence that the public simply isn't anchoring its expectations to the RBI's target the way the framework assumes. So the counter-argument's own preferred channel - credibility-driven expectation anchoring - turns out to be exactly as broken as the wage-bargaining channel it was meant to substitute for.

With both transmission mechanisms empirically absent in the Indian data, what remains is a policy that reliably suppresses output and employment during rate-hike cycles, without the offsetting benefit of actually controlling inflation it was designed to deliver - a cost borne disproportionately by the same informal, price-taking workers the framework's own theory assumed would benefit from stable prices.