I Do What I Do

by Raghuram G. Rajan

why do most countries set their inflation target in the low single digits – 2 to 5 per cent rather than 7 to 10 per cent? Three reasons come to mind. First, even if inflation is at a moderate level that does not hurt overall growth, the consequences of inflation are not evenly distributed. While higher inflation might help a rich, highly indebted, industrialist because his debt comes down relative to sales revenues, it hurts the poor daily wage worker, whose wage is not indexed to inflation. Second, higher inflation is more variable. This raises the chance of breaching any given range around the target if it is set at a higher level. To the extent that a higher target is closer to the threshold where the consequences on growth are adverse, this makes it more likely the country will exceed the threshold and experience lower growth. Third, inflation could feed on itself at higher levels – the higher the target, the more chances of entering regions where inflation spirals upwards.