The Hindu Business Line : Inflation control — Policies that do not yield results

It is not as if inflation cannot be controlled via tight monetary and fiscal policies, despite black money and its purchasing power. However, the price we have to pay is on the real side of the economy: Slackening output and employment growth.

Bhanoji Rao

Inflation used to be the number one problem of the nation for a large part of post-Independence history. An average inflation rate of around 8-10 per cent was ‘normal’ for the economy until the turn of the century. Since then, inflation has got closer to East Asian rates rather than the Latin American ones: 3-6 per cent instead of 10-plus. We just can’t take the high inflation rates any more.

Checking inflation

Business Line, on May 17, reported the skyrocketing of the inflation at, “a 182-week high”. The annualised percentage rate of change in the Wholesale Price Index was 7.83 per cent for the week ending May 3, the highest recorded in 182 weeks, up from the 7.61 per cent a week earlier. For 13 weeks in a row, the inflation rate has been on the rise.

The relatively high inflation was in spite of the Prime Minister, Finance Minister, Chief Ministers, and other policy luminaries proclaiming time and again that inflation would come under check and, of course, announcing a slew of measures to rein in the price rise.

They have even warned hoarders and black-marketers on the perils of inflation.

What has been the policy response of the last few months to tame inflation?

Chapter 4 of the Economic Survey 2008 titled “Prices and Monetary Management”, indicates the tradition of controlling money supply to curb inflation. . The Survey noted that WPI began “firming up from June 2006”.

The causes for escalation since then were traced mostly to “increase in the prices of wheat, pulses and edible oils …and mineral oils”, the last one pumped up by the rising price of crude petroleum.

Anti-inflationary policies

The anti-inflationary policies of the Government included fiscal and monetary discipline (the RBI had hiked the cash reserve ratio several times), rationalisation of excise and import duties of essential commodities; effective supply-demand management of sensitive items through liberal tariff and trade policies; and strengthening the public distribution system.

In our undergraduate days, we read that inflation is the phenomenon of too much money chasing too few goods. It is a problem of both excess demand backed by plenty of money and the lack of supply. So, keep a lid on the easy availability of money and a chunk of excess demand will vanish in a short time, as producers know fully well that the demand is there but only pruned temporarily. Apart from the immediate moderation of the inflation rate, the nation would soon move to a higher production volume and the monetary authority will ease the constraints on money supply, thus helping growth of demand match that of supply.

Monetary policy works when the heavy cause is on the money side. Else, it will only help to pacify those who may be crying for some action instead of waiting and watching.

If black money is driving prices up, monetary policy can do little. If oil prices are up internationally and we are unwilling to allow domestic prices to go up, it is only a policy of postponement. If there is short supply of key commodities globally, tariff policies or trade liberalisation will sound great, but results are likely to be minimal.

It is not as if inflation cannot be controlled via tight monetary and fiscal policies, despite black money and its purchasing power.

The price we have to pay is on the real side of the economy: Slackening output and employment growth. Thus, if lending to consumers and producers is curtailed to an extent enough to significantly curtail demand from all sides, inflation will come down, but output and employment too will fall, perhaps, even more drastically than one would expect. That is not what we need. Instead, it is important that the Centre tells us clearly what exactly is going on and how we are able or unable to control inflation.

An Aside: Which Index?

Inflation rates refer to the annual changes in the Wholesale Price Index (WPI). Globally, most countries use the Consumer Price Index (CPI) variations to denote inflation rates. That practice is justified since the whole exercise of quantifying the inflation rate and taking measures to control it is to ensure that the welfare of the people is least affected by rising prices.

WPI is based on the price data of 435 commodities. Weights attached to them are derived based on the value of quantities traded in the domestic market. As for the CPI, it is based on the consumption baskets appropriate to the groups covered in the indices. Thus, the CPI for industrial workers, for instance, is based on the expenditure patterns of the industrial workers. In fact, it is relatively better known since it is used for wage indexation in Government and in the organised sectors.

WPI does not fully reflect the misery of the common people. We need a representative national CPI along with group and regional CPI.

There are now four different consumer price indexes — CPI-IW for industrial workers, CPI-UNME for urban non-manual employees, CPI-AL for agricultural labourers, and CPI-RL for rural labourers. It is time we have these and, most importantly, a national CPI.

(For information on the author, please visit www.bhanoji.com. E-mail: bhanoji@gmail.com)

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