The monetarist conviction is that excess money creation causes persistent inflation. In other words, money increases are exogenous; the Central Bank can create excess money or decrease it by using instruments like Cash Reserve Ratio (CRR) and or interest rate.
Monetarists are of the opinion that money supply is determined without regard to the value of other variables. This means, there is a statistical relationship between changes in money stock and changes in inflation. At present, the central bank largely uses open market operations to increase or decrease money supply.
Monetary economist Philip D Cagan, for example, assumes that money creation is determined exogenously by monetary authorities, and money supply has a unique relationship with price behaviour. To quote Canadian economist Basil J. Moore: “Credit money is not supplied according to some production function with a resource cost; rather, it is supplied on demand by the Central Bank as the residual provider of system liquidity at a supply price determined exogenously…by the Central Bank itself”.
NO MONETARISM IN INDIA
The above phenomenon, however, is not true in the case of India, where money supply largely increases due to government deficit. Yet, the Reserve Bank is held accountable for liquidity expansion in the economy, which results in higher growth of nominal income rather than real income. If we examine the trend during the past few years, the fact is that government failed to augment supply of goods to match increased demand.
Besides, there cannot be a one-to-one correspondence between money supply and inflation, when the increase in money lies outside the RBI’s control, or when money becomes an endogenous rather than exogenous variable.
In other words, when producers and distributors use their price-fixing power to create a cost-push inflation spiral on the pretext of increases in input cost, industry and business demand more credit for working capital, thus leading to an increase in the quantity of money. This increase in money supply in the current period exceeds the quantity of available goods produced in the preceding period. This endogenously excess supply of money generates inflation (as against the above observation by Basil J Moore). This is what happened in India during 2009-10 to 2011-12.
In our case, money growth was also further aggravated by the stimulus policy of government during 2008-09 and 2009-10. The stimulus policy was also responsible for inflation, as it increased the primary deficit of the Government.
Besides, the RBI also had to accommodate demand for credit to meet the cost-push requirement of money in the economy, though it resulted in inflationary pressure. Cost-push inflation has been self-generating --- credit which went on increasing without corresponding rise in real output. This inflation is not due to the RBI exogenously pumping money.
Therefore, inflation in India is a result of both endogenous and exogenous factors.
RENT SEEKERS UNAFFECTED
Now, RBI is under great pressure from industry, business and banks to cut interest rate, or decrease CRR. Since these variables are exogenous, the RBI uses them in keeping with the situation in the economy. Inflation due to increased RBI credit to government and private sector, and to cover cost-push inflation, is still threatening the economy. The Central Bank (RBI) had raised the interest rate repeatedly (repo and reverse repo) to reduce domestic aggregate demand, and hence inflation.
However, the Central Bank has failed to curb the animal spirits of hoarders of foodgrains, real estate owners and manufacturers of white goods by curtailing their liquidity.
The main objective of RBI has been to mitigate inflation, because inflation in our case has not been caused by excess supply of money. It has been caused by a deliberately reduced supply of several consumer goods.
As a matter of fact, interest rate has not been a successful instrument in reducing monetary liquidity and inflation, as demand for consumer goods is interest-inelastic. So inflation has also been inelastic to interest rate. As a matter of fact, it is inflation which is playing an important role in moving up the interest rate. As in Irving Fisher’s view, nominal interest rates respond endogenously to the expected inflation rate. Thus, when prices show instability, interest rates are assumed to reflect all anticipated changes in the price level.
MULTIPLE FACTORS
We have to realise that inflation is a baby of multiple factors such as: GDP growth, excess money supply, short supply of goods in the market, manipulation in the market, misconceived expectations, exchange rate movement, depreciation of the Indian currency due to large current account deficit, cost-push factor, rise in per capita income and increase in demand due to shifting of population to higher income bracket, and decline in poverty ratio.
The Reserve Bank does not have multiple instruments to control all these variables. It is the government which has to grapple with the complexities of inflation, rather than hold the Reserve Bank responsible for the rise in inflation rate.
(The author is a former Economic Advisor to SEBI.)
Comments:
There can be no second opinion to what is expressed. One factor is the
black money. To the volume of incometax asseees, the quantum of staff
have not increased to monitor the doubtful cases of filing.Industries
like Cine and real estate are abodes of black money over which the
government appears to be soft. One more is the fake currency which
comes through the seas and neighbouring countries. While the fake
currency is rejected in the banks, they are in float among the public
and have legal tender for transactions. A couple of years ago,there
was a report that in Lucknow, the statebank issued fake currency for
the salaries of CISF/BSF. There was another report in the same tempo
about the involvement of many members of Samajwadi party. The public
are not aware what was the action taken over such blatant attempts to
derail the national economy. Government suppresses inconvenient
answers but leaks that are only favourable to it. Why not government
take confidence of its citizens?
"Besides, there cannot be a one-to-one correspondence between money supply and inflation, when the increase in money lies outside the RBI’s control, or when money becomes an endogenous rather than exogenous variable. " -
The above is a total bunkum. Why the Indian english media fooling itself on imaginary theories? Writer of this article proves Economics is a subject one can twist to suit ones imagination.Economists probably can be seen but definitely not heard.
Inflation in india is mainly due to global slowdown, euro zone crisis,rupee depreciation which has disturbed current /fiscal deficit. Interest of poor people who are below poverty line can not be ignored hence govt hands are tight to reduce subsidies.Subsidies on diesel which is being usd by car owners needs to be stopped.Subsidy on cooking gas cylinder who are earning more then appropriate amount, be stopped What is important that when Reserve bank can deregulate interest on NRE/FCNR deposits, why not in similar way can reduce repo /reverse repo rate when it is demanded from all sectors. Public sector Banks if make agreesive, result orientive marketing, and make customers to use NEFT ,RTGS, ECS, NET BANKING ,ATMs,,Banks can reduce transaction cost, improve profitability.Similarly Banks have to control frauds, Bad loans.
Following are the reasons for Inflation : (1) Increased support price for agri produce. There are only few farmers who can sale their produce It is only the rich land lords who sale their produce. Small farmer, marginal farmer actual buys the agri produce. Majority of the farmers are small or marginal farmers. Majority of Indian population is rural. Majority of rural population is small and marginal farmers, and agri labourers. Thus by increasing farm produce prices, the one who suffered most is the farmer. A thorough scientific study is needed to assess how muchrural population will benefit by increasing farm produce prices. (2) Increase in salaries. Due to 6th pay commission, the salaries increased by 50% and more at one go .it was implemented some time in 2008 and later as per centre and state decisions. Besides increase in salaries the arrears from 1.1.2006 were paid in 2009 on wards. It is essential that pay commission announces the revised pay scale on right time .
Public at large should also think that increase in price reduces consumption and thus allow govt to increase the price of petrol and diesel which cause air pollution and is also imported at cost of valuable foreign exchange. Every Govt vehicle must be given monthly quota of diesel/petrol, present quota if any be reduced by 10 per cent. To effect curb on private use of vehicles, public transport system (by all local bodies and the state and central government) must be drastically improved. Vehicle manufacturing companies should be given incentive for every new version of vechicle which has substatially low consumption. Street procession, marriage barats road blocks etc cause trafick jam and increase fuel wastage. All this should be stopped.All jobs and machinary where fuel/power cousumption is involved should have some standards by certification. (5) Wastage of food increase burden on supply side and increases inflation. Spoilage of food in govt.storage, transport is wel-known.
The food wasted on table is not noticed - in hotels, parties and in some homes. In 1965-66, Lal Bahadur Shastri had announced Saturday as fast day, and all hotels and public at large observed it honestly can we on our own think on that line. It is good for health also. (5) Hoarding of commodities is a known cause of inflation. Governments are not seen acting on this. On the contrary, government announcement have led to such activity. A few days ago, Agriculture Minister announced that there would be less production of pulses. Was it necessary? On the contrary announcement should have been that we are importing such such pulses from such such countries. Additional one killogram of storage by ever family in this huge country could lead to substatial increase in prices of pulses.
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