- Intro – state current inflation scenario.
- India’s current inflation targeting model.
- What is the need for agricultural price control in inflation ?
- Conclusion & way forward.
Inflation is defined as the sustained rise in general prices over a period of time. India’s WPI inflation has recorded double digits for over 12 months, while CPI inflation has breached the RBI’s upper target of 6% for 3 consecutive months. In reaction, the Monetary Policy Committee has raised the repo rate by 40 basis points, besides, warning of its consequences.
How India’s manages inflation now ?: ‘Inflation Targeting’ is a stated policy of RBI, implemented through changes in interest rate to control inflation. The basic premise is that since inflation reflects excess of output over its ‘natural level’, increasing the repo rate will induce firms to withhold or reduce investments, lowering production. As economy wide output declines, it will settle to its ‘natural level’, ceasing inflation. So, output contraction is seen optimal for inflation targeting. At the natural level of output, the economy is deemed to be at full employment.
However, ‘natural level of output’ is an unobservable quantity. Thus, a theory based on unobservable variable – the proposition that inflation is due to “overheating” economy – fares poorly when put to statistical test.
Need for alternate model ?: An alternate model to explain inflation is proposed in terms of prices of agricultural goods and, to a lesser extent, imported oil. This model curtails monetary policy’s control on inflation; the only route by which monetary policy can control inflation is by curbing growth of non-agricultural output. But, this, in-turn, will lower demand for agricultural goods, affecting output & employment.
Inflation is mainly driven by food, i.e., agricultural goods prices. Thus, focus on increasing the supply of these goods will be a win-win solution requiring faster agricultural growth, expanding the economy without inflation. Ideally, food price will come down resulting in rise in demand for other goods, that will propel the economy forward. India’s growing per-capita income has shifted the average consumption basket towards foods rich in minerals, like fruits, vegetables and protein. But the expansion of these foods has been lower. So a concerted drive to increase supply of food other than rice and wheat can hold the key.
Way forward: Increasing agricultural supply at a steady if not declining prices is challenging. Costly foods threatens health as people economise on food intake, and retrenches the economy as only a very small portion of household budget can be spent on non-agricultural goods. Changing interest rate is not an efficient method for agricultural price-driven inflation. This requires raising agricultural productivity by re-orienting the farm policy. Green Revolution had focussed on raising the output of superior cereals, causing inflation by continuously raising procurement prices for these crops and slow growth in others. Hence, an equitable solution is needed for India’s growing inflation menace.