Third, monetary policy has no effects on inflation when the economy is supply constrained, so we should abandon our attempt to control it. Fourth, the central bank has little control over inflation when government spending dominates (what in the jargon is called “fiscal dominance”).
The wrong index Historically, the RBI targeted a variety of indicators, putting a lot of weight on the Wholesale Price Inflation (WPI). Theoretically, reliance on WPI has two problems. First, what the common citizen experiences is retail inflation, that is, Consumer Price Inflation (CPI). Since monetary policy “works” by containing the public’s inflation expectations and thus wage demands, Consumer Price Inflation is what matters.