## Saturday, January 15, 2011

### Deciphering and solving the inflation crisis

India has an inflation crisis. From 2006 onwards, the yoy rise in CPI-IW seems to have gone unhinged:

Why did this happen? We have a `Nobody killed Jessica' situation here. Sharad Pawar and D. Subbarao both insist that the problem cannot be laid on their doorstep. I would argue that it was the currency policy from 2003 onwards (large purchase of dollars with partial sterilisation) which gave us this mess, which was then compounded by repeated RBI speeches saying that inflation is not important, and RBI actions which were soft on inflation.

The weakness of macroeconomic thinking in official circles is visible, with government actions including banning exports, sending the police to raid traders and hoarders, etc. I believe there is an iron law of economic policy: across each doubling of GDP, you have to reinvent government. The trouble in India is that we are getting each doubling of GDP in a decade or less, giving a very large gap between the structures of government and the underlying conceptual frameworks, when compared with the requirements of the economy. With agriculture at only 15% of GDP, one has to think differently about the role of food in inflation as a macroeconomic phenomenon.

Getting back to stable 4% inflation is terribly important, and it's going to be hard. In recent weeks, Ila Patnaik has written four newspaper pieces which add up to an interesting perspective on inflation: 20 Dec, 25 Dec, 3 Jan, 13 Jan. And, a blog post of mine on food price volatility may also be useful.

1. Hi Ajay, you think differntial pricing of Diesel for commercial vehicle and cars could be the possible solution in present realities of Govt. Though not a major solution but at times small ideas do work. It's just that policy advisors like you can bring this up and help the Petrolium Ministry take up for action. Any views? - Jinendra M. Shah (jinendra.shah@baml.com)

2. I have a basic question with respect to this inflation problem..In an Indian scenario, how do you distinguish between supply side inflation & demand side inflation..I acknowledge that there could be both happening simultaneously..But determining which one is dominant is crucial in deciding how to tackle it.. And how effective is tackling supply side inflation with demand side instruments & vice versa ( eg: fighting petro-price based inflation with monetary adjustments) ?

3. I am curious to know why my comment was not published. I think my comments meet all of the guidelines stated by you. Are there any other unstated guidelines, that I have overlooked ?

RN

4. If Inflation has been an issue since five years, why haven't any wonks, policymakers made it an issue. Is there anyone in our financial press who made an issue of it, before the current iteration of the crisis.
Why wait till shit hits the fan.
-A2

5. Dear R,

My apologies. Could you please talk with me by email? I am not aware of the facts.

Please note: Comments are moderated. Only civilised conversation is permitted on this blog. Criticism is perfectly okay; uncivilised language is not. We delete any comment which is spam, has personal attacks against anyone, or uses foul language. We delete any comment which does not contribute to the intellectual discussion about the blog article in question.

LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.