The Hindu Business Line : Inflation and growth dynamics

The subject of inflation and growth dynamics generates debates, especially in regard to the approaches — structuralist or monetarist. According to the structuralists, inflation has a positive impact on growth while the monetarists argue that inflation has a retarding effect.

In this context, Tobin (1960) propagated that as money and capital are substitutable, an increase in the inflation rate could lead to capital accumulation, which in turn establishes a positive relation between inflation and economic growth, called the Tobin Effect. Some economists see a direct relationship between inflation and economic growth up to certain point but there could be trade-offs beyond that threshold.

The Threshold

The question is has the inflation rate in India crossed the threshold that can impair the growth rate of the economy? According to the Reserve Bank of India, 5-5.5 per cent is the inflation threshold for the economy. Beyond this level, there can be different implications for different sections, as also on the real growth rate and employment levels.

Inflation is especially hurting for the fixed-income group, the urban educated unemployed and, of course, the poor. The producers get relief by simply passing on the price burden. The concern is that this widens the gap between rich and poor in an economy where there already exist wide inequalities.

In this context, the role of monetary and fiscal policy assumes importance in curbing the price rise and mitigating its deleterious effects. Empirical studies point out that if inflation affects growth, the monetary policy ought to strive for price stability through vigorous anti-inflationary policies.

The monetary authority in India has taken such measures as raising the repo rate, increasing the Cash Reserve Ratio and preventing the excess flow of money from non-banking financial institutions to traders as that may lead to excessive speculation in the commodity market. To complement them, the Centre has taken such fiscal steps as banning export of essential goods, cutting import duty on essential items and measures to enhance agricultural productivity.

Labour move, the key

The policy-makers are also looking at the idea of moving labour away from agricultural activities. Such a diversification would lead to consolidation of land holdings and usher in a technological revolution on the field thereby raising productivity. Fragmented land-holding, with a concentration of human resource, reduces technology application, resulting in a retrogression of agricultural productivity and leads to social and economic problems in the hinterland.

Thus, in order to enhance the agricultural productivity and stabilise the price level, government policy must promote diversification of human resource away from agriculture to non-farm enterprises alongside a technological revolution on the field. Sans growth in agriculture, the overall economy will remain suppressed as there is considerable scope for forward linkages from the farm to the factory. The policy-makers should not be complacent with the growth that is unbalanced. A more balanced growth may take the economy more rapidly to the league of developed nations.

(The author is an Assistant Professor at the Centre for Development Studies, Thiruvananthapuram.)