Do Actions Match Words? Reassessing the Taylor Rule in an Emerging-market Context 
The Reserve Bank of India (RBI) formally adopted a flexible inflation targeting (FIT) framework in 2015 that requires the central bank to aim for a 4 percent headline consumer price index (CPI) inflation rate with a tolerance band of plus or minus 2 percentage points. The RBI’s monetary policy stance was previously informed by multiple economic indicators. This paper examines whether the RBI’s monetary policy communication has been aligned with its actions since adopting FIT. This consistency is especially important for emerging economies, in which institutional credibility and inflation expectations are still evolving and supply shocks are frequent. The authors analyze the text of the RBI’s monetary policy statements before and after it adopted FIT to measure how much emphasis the RBI’s communication places on stabilizing inflation. They then use Taylor-type reaction functions to infer how much importance the RBI’s actions place on inflation stabilization, that is, the extent to which the policy rate responds to inflation and the output gap.
Key Findings
- Word-frequency analysis of all RBI monetary policy statements issued from 2000 to 2025 shows a semantic shift from words associated with multiple economic indicators to a greater focus on inflation and in more forward-looking terms after FIT adoption.
- The authors’ estimates using standard Taylor rules suggest that the policy rate has not responded significantly to inflation since the RBI’s adoption of FIT, implying that while the central bank’s communication has become more focused on inflation, its actions have not exhibited a corresponding change.
- When the authors use a forward-looking framework that incorporates the RBI’s internal forecasts, they find that the responsiveness of the policy rate to expected inflation has increased since the adoption of FIT, suggesting a greater role for forecast-based, forward-looking decision-making.
- They further estimate a hybrid specification that shows the RBI responds to both expected and realized inflation, consistent with a similar hybrid orientation in its communication.
- The evidence suggests that when the RBI’s communication and policy actions are viewed through the correct empirical lens, they exhibit alignment after the adoption of FIT, supporting the interpretation of central bank credibility.
Implications
The authors’ findings underscore the need for richer empirical frameworks—beyond standard Taylor rules—to capture central bank behavior in emerging economies. They also show that evaluating monetary policy credibility requires correctly modeling the information set on which the policymakers act. Finally, they highlight the importance of macroeconomic forecasting in an inflation-targeting regime.
Abstract
Backward-looking Taylor rules, widely used to characterize central bank behavior, can misrepresent policy when central banks base decisions on forecasts. This mischaracterization affects the assessment of credibility, defined as alignment between a central bank’s words and actions. We examine this issue in the context of India’s adoption of flexible inflation targeting (FIT) in 2015. Text analysis shows that the Reserve Bank of India’s (RBI) communication became more inflation-focused and forward-looking after FIT adoption. Yet backward-looking Taylor rules show no robust increase in responsiveness to realized inflation, suggesting lack of credibility. This misalignment disappears when we analyze policy-relevant information through a forward-looking lens. Using the RBI’s real-time inflation and output forecasts, we find significant responsiveness to expected inflation post-FIT. Hybrid reaction functions show that post-FIT policy responds to both expected and realized inflation. The analogous evolution in communication and conduct points to the RBI’s credibility. More broadly, our results demonstrate that hybrid reaction functions may better characterize emerging-market central bank behavior than purely backward- or forward-looking specifications.