RBI’s inflation targeting faces public perception gap

inflation
The RBI’s inflation targeting is challenged by a persistent gap between household perceptions and actual price trends.

The Reserve Bank of India and fiscal authorities have done a credible job in containing inflation expectations, which had surged during the COVID-19 pandemic. According to the latest RBI Bulletin, improved domestic economic conditions and timely policy responses helped bring those expectations down. Even so, in a world marked by geopolitical shocks, supply chain disruptions, and volatile commodity prices, the RBI continues to walk a tightrope between controlling rising prices and supporting growth.

An article in the RBI Bulletin on household inflation expectations sheds light on a persistent mismatch between perceptions and reality. Indian households, the study notes, have consistently expected higher inflation than professional forecasters or businesses — even during periods when price increases were low and stable. This gap has persisted for nearly two decades, including between 2014–15 and 2019–20, when actual cost push remained within a narrow band.

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The reasons lie partly in the way ordinary consumers experience the economy. Households tend to form expectations based on their day-to-day spending — particularly on food, housing, and fuel — which are subject to frequent price swings. This is especially true for vulnerable groups such as older individuals, the self-employed, and daily wage earners. In contrast, younger and salaried individuals, who are more likely to access financial information and engage in formal networks, tend to align more closely with actual inflation data.

Flexible inflation targeting

India adopted the flexible inflation targeting framework in 2016, with the goal of anchoring price surge expectations and providing policy stability. Under this regime, the RBI is mandated to keep retail inflation at 4%, with a tolerance band of ±2 percentage points. Unlike strict inflation targeting, this framework allows room to accommodate growth and employment considerations, making it better suited to India’s developmental needs.

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Since its introduction, flexible targeting has helped in moderating price volatility and improving policy credibility. Households and firms have gradually adjusted to a more predictable regime. However, the study suggests that while expectations have come down over time, households still respond sluggishly to actual price moderation.

Role of global and domestic shocks

The upward bias in inflation expectations has been exacerbated by a series of macroeconomic shocks. Food price spikes — often driven by unseasonal rains, droughts, or global supply disruptions — tend to weigh heavily on household sentiment. More recently, the COVID-19 pandemic, followed by global supply chain bottlenecks and geopolitical tensions, pushed up price surge expectations, particularly in categories like food and housing.

The data shows that in the second half of 2024–25, as headline inflation began to ease, professional forecasts adjusted more quickly than household expectations. This lag highlights a structural challenge: expectations formed by households are more resistant to change, and therefore more difficult for policy to influence.

Why it matters in policymaking

Persistent high price expectations among households can reduce the effectiveness of monetary policy. If people believe prices will continue to rise, they are more likely to demand higher wages or increase current spending. This can feed into actual inflation, making it harder for the central bank to bring prices under control.

This creates a policy dilemma. The RBI may be compelled to tighten monetary policy even when inflation data suggests moderation. In such a scenario, achieving the twin goals of price stability and economic growth becomes harder. Moreover, the flexible inflation targeting framework itself can be undermined if the public does not believe in the central bank’s ability to hit its target.

Need for continued coordination

Despite the progress made through flexible inflation targeting, challenges remain. The study reveals the need for continued coordination between fiscal and monetary authorities. While monetary policy can influence demand-side drivers of high prices, it is less effective against supply shocks. Fiscal tools — such as export restrictions, reduced import duties, or targeted subsidies — have proved useful in stabilising food prices and tempering inflation expectations.

However, these measures need to be deployed judiciously. Over-reliance on trade restrictions, for instance, can distort markets and reduce long-term efficiency. The broader task is to build resilience in agricultural supply chains, invest in storage and logistics, and expand access to timely market information for farmers and consumers alike.

The global environment remains volatile, and India’s inflation outlook is shaped as much by international developments as by domestic policy. In this context, the RBI’s role goes beyond setting interest rates. It must continue to engage in clear communication, build public trust in its inflation targets, and strengthen the credibility of the FIT framework.

At the same time, policymakers must address demographic and sectoral disparities in inflation perceptions. Without bridging the gap between household expectations and actual inflation trends, even the best policy frameworks will struggle to deliver price stability. The path forward lies in integrating targeted fiscal measures with credible monetary action—grounded in data, and responsive to the lived experience of Indian households.