MBF 2025-wl-11331-Inflation Targeting in the Third World: A Kaleckian Perspective

Monetary policy world over, in the post–monetarist era, is premised on targeting inflation, which assumes a trade off between output and inflation. A rise in the policy rate, by bringing the level of activity down, can tame inflation. But what if the slope of the New Keynesian Philips curve is indistinguishable from zero? Far from reducing inflation, it may lead to stagflation. On the expansionary side, the premise is that a fall in interest rate will increase output by persuading firms and households to invest more in factories and residential assets respectively. Yet again, unless the IS curve is responsive to the interest rate, especially a decline in it, monetary policy can hardly be expansionary. This paper attempts to test the New Keynesian macroeconomic (NKM) framework empirically and present a Kaleckian alternative, both empirically and theoretically, which is more suited to third world economies such as India’s, where structural constraints play a key role.