Spe Dynamics

8/16/2019 Spe Dynamics

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Dynamics of Inflation

by

Dr. C. Rangarajan*

ChairmanEconomic Advisory Council to the Prime Minister

I feel greatly honoured to deliver the P.R. Brahmananda memoriallecture. Prof. Brahmananda was one of India’s outstanding economists,having made significant contributions to the development of economicthought in India. He has not been afraid to articulate his views on economicpolicy even when he was in a minority. In the early decades after

Independence when almost all economists and policy makers were in favour of a path of development which emphasised industrialisation and moreparticularly in heavy industries, he along with Prof. .!. "akil stood out infavour of an alternative path which emphasised the development of wagegoods industries including agriculture. Perhaps, if India had adopted thealternative route, the growth rate in the earlier period might have been muchhigher than what it turned out to be. Prof. Brahmananda was also a leadingmonetary economist of the country. He was a crusader in the cause of fighting inflation. He was convinced that high growth was possible only in an

environment of low inflation. ontrol of money supply, according to him, waskey to controlling inflation. In this lecture which has been instituted tohonour his memory I, therefore, have chosen to speak on #ynamics of Inflation, a sub$ect dear to his heart.

Inflation may be broadly defined as the sustained increase in prices.Prices can be measured either by the wholesale price inde% or the consumer price inde%. In India, policy makers very often use the wholesale priceinde%. &his is so only because of the speed with which these data areavailable. It is true that the two indices do not always show the same

behaviour. In years when food inflation is high, the retail inflation is alwayshigher, as food commodities have a higher weight in retail price inde% than'PI (&able ) and hart )*. Between +-/ and +))), this is whathappened.

• P.R. Brahmananda 0emorial 1ecture delivered at 23 th 4nnual onference of &he

Indian 5conomic 4ssociation held at 6I&40 7niversity, "isakhapatnam on#ecember +/, +)+. &he author is thankful to 0r. 5.0. "ibeesh for his assistancein the various statistical calculations.

1


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able !" #holesale and Retail Inflation

$ear #PI CPI %I#& CPI %I#&'(ood

+38 9.9 9.9 9.)

+8- 8.8 8.- 2.+

+-/ 9.- 8.+ /.9

+/2 /.) 2.) )+.:

+2) :./ )+.+ )3.+

+))) 2.8 ).3 2.2

+)))+ /.2 /.9 8.:

&he two interesting ;uestions that arise in the conte%t of e%plaining thephenomenon of inflation are ()* what causes inflation


3/26

Chart !" #hole sale and Retail Inflation

3


4/26

)roth and Price +tability

4 crucial issue in the conduct of policy is whether the pursuit of theob$ective of price stability by monetary authorities undermines the ability of

the economy to attain and sustain high growth. 5mpirical evidence on therelationship between growth and inflation in a cross country framework issomewhat inconclusive because such studies include countries with aninflation rate as low as one to two per cent to those with inflation rates goingbeyond + to : per cent. &hese studies, however, clearly establish thatgrowth rates become increasingly weaker at higher rates of inflation (Bruno,)223*.

&he tradeoff between price stability and economic growth has beendiscussed in the framework of labour and output markets. &he well known

Phillip’s curve postulated an inverse relationship between unemploymentand wage rate. =everal economists have challenged the basic microeconomic underpinning of the wage and price mechanism that leads to thepossibility of tradeoff between inflation and growth. =everal studies haveestablished that in the long run there is no tradeoff between the two. &hePhillip’s curve becomes purely vertical, if the role of e%pectations is e%plicitlyincluded. 4n environment of reasonable price stability is more conducive toeconomic growth> price stability is thus a necessary condition for long rungrowth. However, there is a possible tradeoff in the short run. It is,

nevertheless, important not to over use this opportunity as it can underminethe long term imperative.

&he case of price stability as a ma$or ob$ective of economic policyrests on the assumption that volatility in prices creates uncertainties indecision making. Rising prices adversely affect savings while they makespeculative investments more attractive. &hese apart, there is a crucialsocial dimension, particularly in developing countries. Inflation adverselyaffects those who have no hedges against it and that include all the poorer sections of the community. &his is indeed a very strong argument in favour of maintenance of price stability in emerging economies.

In resolving the short run tradeoff between price stability and outputgrowth, in the industrial countries, a solution is sought through the adoptionby policy makers of rule bound monetary policies such as the &aylor’s rule.&he &aylor rule prescribes that the signal interest rate be fi%ed taking intoaccount the deviations of inflation rate from the target and actual output fromits potential. &he rule re;uires the federal funds rate in the 7.=. to be raised,


5/26

if inflation increases above the target or if real 6#P rises above trend 6#P.In the original version, the weights of deviation from target inflation andpotential output were assumed to be the same at .3. However, it wassubse;uently felt that the coefficient of inflation deviation term must behigher at one. 'hile the rule is intuitively appealing, there are seriousproblems in determining the values of the coefficients. &here is also a lot of

$udgment involved in determining the potential output and target inflationrate. However, the rule offers a convenient way of determining when theentral Bank should act.

4nother way of reconciling the conflicting ob$ectives of price stabilityand economic growth in the short run is through estimating the ?thresholdlevel of inflation@, a level beyond which costs of inflation begin to rise steeplyand affect growth. It is this inflation threshold that can provide some

guidance to the policy makers. Below and around this threshold level of inflation, there is greater maneuverability for the policy makers to take intoaccount other considerations. Interestingly, the hakravarty ommitteeregarded the acceptable rise in prices in India as 9 per cent. &his, accordingto the ommittee, will reflect changes in relative prices necessary to attractresources to growth sectors. I have myself indicated that in the Indianconte%t, inflation rate around 3 per cent may be acceptable. =ome studieshave estimated the level of threshold inflation in India to be in the range of 3to 8 per cent. &here is some amount of $udgment involved in this, aseconometric models are not in a position to capture all the costs of inflation.&his approach provides some guidance as to when policy has to becometight or to be loosened. It is also necessary for the policy makers to notethat this order of inflation is higher than what the industrial countries areaiming at. &his will have some implications for the e%change rate of thecurrency. 'hile an open economy helps to overcome domestic supplyshocks, it also imposes the burden to keep the inflation rate in alignmentwith other countries (Rangara$an, )22/*.

Current Inflation

'e have had three years of high inflation (hart +, &able +*. Inflationhas remained above - per cent since !ovember +2. +2) was badlyaffected because of the deficient monsoon. Aoodgrain production declinedby )- million tonnes. &he decline in the production of rice alone was ))million tones. 4s a conse;uence, inflation was triggered by the increase infoodgrain prices. Aood inflation which crossed the double digit level in une

5


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Chart 2: Behaviour of dierent Components of Whole sale Ination


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able ," -ehaviour of different Comonents of #hole sale Inflation

$ear Month

Inde/ Inflation %$'o'$&

(oodArticle

0on(ood)rain

0on(ood MP

AllCommodities

(oodArticle

0on(ood)rain

Article

0on(oodMP

AllCommodities

, 1 1 2

3an ))/.2 ))9.// )2./: ))+.9 )).9: ).) 8./: 8.89

(eb ))2.+ ))3.:- )).) ))+.8 )+.:3 )).// 8.-3 8.8:

Mar ))/.2 ))8.): )).83 ))+./ ):.+9 )9./ 8.-8 8.-+

Ar )+).3 ))2.)+ ))+.:+ ))9.3 )9.)2 )9.-3 3./) 8.++

May )++.: )+.33 ))+.3- ))9.- )+.2: )9.)/ 3.9: 3.3+

3une )+)./ ))2.29 ))+.8/ ))9./ /.29 2.- 3.)/ 9.98

3ul )+9./ )+:.+- ))+.-) ))3.- )).+: )).3/ 9.3+ 9.9+

Aug )+8.) )+9.- ))+./- ))8. 2.-3 2.88 9.+ 9.9

+e )+3.3 )+:./+ ))+.28 ))8. 8.+- 8.+/ :.2) :.:2

4ct )+8. )+:.+2 )):.33 ))8.: 3.)/ 3.- 9.+3 :.)20ov )+3.+ )++.): )):.-) ))8./ 9.9+ 3. 9.:/ :.-:

Dec )+).8 ))-.9: ))9.+ ))8.- :.+: :.-: 9.9/ 9.)

, 1 1 5

3an ))2.2 ))9.-- ))3.8+ ))-.3 ./9 .) 3.+- 9.39

(eb )++.3 ))-.28 ))8.9 ))2. +.-- +.+9 3.-: 3.8/

Mar )+3.8 )+)./ ))/.+ )+).3 3.8: 9.+8 8./+ -.-)

Ar )+/.2 )+9.-+ ))2.-3 )+:.3 8.2 9.- 8.8) -./8

May ):.+ )+8.8: ))2.- )+9.) 8.98 3.9 8.:: /.+

3une ):.: )+8.8 )+).)9 )+-.: 8.2/ 3.33 -.3 )./2

3ul )::.9 ):.+/ )+)./) )+/.8 8./2 3.82 /.- )).)3

Aug ):9.9 ):.29 )++.)) )+/.2 8.3/ 3. /.)2 )).)++e ):3./ ):+.-- )++.+ )+/.3 /.+) -.+: /.+ ).-/

4ct )9.: ):-.92 )+)./3 )+/.- )).:3 )).3+ -.:) ).88

0ov )9).) ):/.)9 )+.:/ )+8.2 )+.- ):.)) 3./- /.83

Dec ):8.: ):).:/ ))2.:2 )+9.3 )+.2 )).// 9.- 8.8/


8/26

Table 2: Continues

$ear Month


(ood

Article

0on(ood

)rain

0on(ood

MP

AllCommo

dities

(ood

Article

0on(ood)rain

Article

0on(ood

MP

AllComm

odities

, 1 1 6

3an ):-.+ ):+.++ ))2.:/ )+9.9 )9.9: )3.+ :.+3 3./-

(eb ):9.) )+8.// ))/.28 )+:.: 2.9- -.3- +.+ :.8)

Mar ):3.8 )+/.28 ))2.+: )+:.3 -.28 8.3) ./- ).83

Ar )9.) ):9.:+ ))2./ )+3. /.82 -.82 .38 ).+)

May )9)./ ):8.3 ))2.9) )+3.2 /.2) -.99 .+9 ).93

3une )93. )9.) ))2.39 )+8./ )).+/ ).8- ).:+ .:2

3ul )3.9 )9-.3 ))2.8 )+/.+ )+.-9 )+./- )./) .:)

Aug )3:.- )3.-/ )+.+ )+2.8 )9.:8 )3.)8 ).-) .39

+e )39.- )3.2) )+.:+ ):.: ):.2+ ):.8- ).:2 ).9

4ct )3-./ )39.)3 )+.9/ ):). )+.9- )+.)+ ).): ).-20ov )89.- )8).8 )+.38 ):+.2 )8.-: )8.32 .)3 9.-:

Dec )89.8 )32.8 )+.29 )::.9 +.-8 +).9/ ).: -.)3

, 1 ! 1

3an )89.2 )32.: )++.:+ ):3.+ +.)2 +.9/ +.98 /.8/

(eb )8:.9 )3/.-+ )++.8+ ):3.+ +)./3 +3.2 :./ 2.83

Mar )8:.8 )8.)9 )+:.9) ):8.: +.83 +9.)/ :.3) ).:8

Ar )8/./ )8-.3: )+8.2 ):/.8 +.92 +9.-: 3./2 ).//

May )-+.) )-+.- )+8.++ ):2.) +).:- +8.9/ 3.- ).9/

3une )-3.9 )-8.+ )+8.- ):2./ +.2- +3.-- 3.9- ).+3

3ul )-/.+ )-2.-/ )+8.3 )9). )/.9/ ++.+3 3.:2 2.2/

Aug )-8.- )--.8 )+8.+- )9).) )9.28 )-.-2 3.+) /./-+e )-2.2 )/+.:3 )+8.8: )9+. )8.+2 +./: 3.+9 /.2/

4ct )/.2 )/:.// )+-.)+ )9+.2 )9.89 )2.+/ 3.3) 2./

0ov )/).9 )/9.+3 )+-.3 )9:./ ).)9 )9.:2 3.-8 /.+

Dec )/2.9 )23.- )+/.93 )98. )3.- ++.++ 8.+) 2.93

8


9/26

Table 2: Continues

$ear Month


(oodArticle

0on

(ood)rain

0on

(oodMP

All

Commodities (oodArticle

0on(ood

)rainArticle

0on

(oodMP

All

Commodities

, 1 ! !

3an )2+.9 )2/.-2 ):.: )9/. )8.8/ +9.-2 8.3: 2.9-

(eb )/).: )/+.9- ):+.: )9/.) ).23 )9.2- -.8/ 2.39

Mar )-2. )/.:9 )::.// )92.3 2.9) )+.8) /.9/ 2.8/

Ar )/8./ )2).:+ ):9.2 )3+.) ).88 )9.+ 8.22 2.-9

May )/8.: )2.3 ):3.:2 )3+.9 /.+3 ).93 -.+8 2.38

3une )//./ )2:.3/ ):3./2 )3:.) -.89 2./8 -.-/ 2.3)

3ul )2+./ )2/.9- ):3.-9 )39.+ /.)2 ).9 -.82 2.:8

Aug )2:.- )22.)8 ):8.) )39.2 2.8+ )+.)9 -.-/ 2.-/

+e )2-.+ +:.-8 ):8.8/ )38.+ 2.8+ )).-3 -.2: ).

4ct )22.: +3./9 ):-.:/ )3-. ).)- )).29 /.- 2./-

0ov )28.3 ++.2 ):/.+: )3-.9 /.:+ 2.82 /.9+ 2.98

Dec )2.2 )29.:2 ):/.-) )3-.: .-2 .:3 -.22 -.-9

, 1 ! ,

3an )2).) )29.+3 ):2.:2 )3/.- .8/ +.+/ 8.2/ -.+:

(eb )2+.9 )23.2/ ):2.-9 )32.: 8.)+ -.9) 3./9 -.38

Mar )2-.) +).8) )9.8 )8). ).)) ))./ 3.+ -.82

Ar +-.+ +)9.39 )9).82 )8:.3 ).2+ )+.)9 3.: -.3

May +8.) +)+.93 )9+.9: )8:.2 ).8: )).-/ 3.+ -.33

3un +2.9 +)3.-2 )9+.22 )89.- ).2) )).9- 3.+: -.3/

3ul +)+.9 +)-.9/ )9:.9+ )83./ ).)- 2.3/ 3.88 -.3+

Aug +))./ +):.92 )9:.23 )8-.: 2.:9 -.)2 3.-- /.)+e +):.) +):.8 )99.3) )8/./ /.8 9./: 3.-: /.-

4ct +)+.3 +)+.22 )99.3) )8/.- 8.8+ :.9- 3.)2 -.93

0ov +):.+ +):.98 )99.9: )8/./ /.3 3.8: 9.92 -.+9

+2 crossed + per cent in #ecember +2 and stood at that level tillune +). Cverall inflation as measured by the wholesale priceinde% started rising from #ecember +2 and crossed the ) per cent markin 0arch +). 4t that point nonfood manufacturing inflation was still low at:.3 per cent. It was e%pected that inflation would moderate through +))).&his in fact started happening and the trend continued till !ovember +).Arom the peak of ).2 per cent in 4pril +), it came down to /.+ per cent in!ovember +).

9


10/26

However, prices started rising after that because of unseasonal rainswhich triggered food prices to rise again. By 0arch +)), year on year inflation had touched 2.- per cent. 'hile the food price inflation of +2)was triggered by the rise in foodgrain prices, in +))) it was triggered bythe rise in the prices of vegetables, fruits and eggs, meat and fish. &heincrease in vegetable prices was significant. &he late rains had a severeimpact on the supply of some vegetables including onion. Inflation invegetables rose to :9 per cent in #ecember +) and 8- per cent inanuary +)). !ormally, vegetable prices show a seasonal decline duringwinter months. #uring +))), prices of raw cotton rose on an average by9: per cent. &he persistence of food inflation led to the spread of inflation toother sectors. Inflation in nonfood manufactures rose from :.3) per cent in0arch +) to /.3 per cent in 0arch +)), with the weighted contribution of the manufacturing sector to total inflation at 9)./ per cent.

Inflation continued to remain an area of concern through most of +)))+. Arom 4pril +)) to !ovember +)) for eight consecutive monthsinflation remained above 2 per cent. &he break came in #ecember +))when inflation fell to -.- per cent and it fell further to -.+ per cent in anuary+)+. Inflation in food articles eased from ).- per cent in 4pril +)) to.8/ per cent in anuary +)+. &he significant decline in the headlineinflation was primarily due to the strong decline in food articles and that tooparticularly in vegetables. &he relief from the decline in food inflation wasshort lived. Both headline inflation and food inflation started to rise from thelow levels reached in anuary +)+. 5ven as of !ovember +)+, foodinflation is as high as /.3 per cent. Headline inflation after remaining steadyat around -.3 per cent rose to / per cent in 4ugust and =eptember +)+.=ince then, we have seen a decline with the !ovember figure touching -.+per cent. !onfood manufacturing inflation has declined from / per cent in#ecember +)) to 9.92 per cent in !ovember +)+. However, PI inflationstill remains at double digit level.

10


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+ome 7ey 8uestions

In the conte%t of the analysis of the inflationary developments in the lastthree years some key ;uestions arise. &hese areD

). In a situation where inflation is primarily triggered by rise in food prices,what is the role of monetary policy<

+. How much weight should policy makers attach to considerations ofgrowth while fighting inflation<

:. 'hat has contributed to the persistence of food inflation in India< anmonetary policy play any role in moderating food price inflation<

9. 'ith the emergence of certain structural rigidities in price formation

should the acceptable level of inflation be higher than before<

Role of Monetary PolicyIt is true that the e%traordinarily high level of inflation seen in the last

three years is due to certain severe supply side constraints, particularly of agricultural products (Basu, +))*. &he fact that inflation is triggeredprimarily by the supply side shocks does not mean that monetary policy or for that matter fiscal policy has no role to play in such conditions. 4s

indicated earlier, food price inflation, if it persists long enough, getsgeneralised. !onfood manufacturing inflation, sometimes called the coreinflation, can be treated as an indicator of demand pressure. &his has alsoremained high since 4pril +). In 0arch, Cctober and !ovember +)) ithad crossed / per cent despite a declining growth rate in output. &husmonetary policy along with fiscal policy have to play their part in containingthe overall demand pressures. &his calls for a tightening despite the originsof inflationary pressures (0ohanty, +))*.

It is only in this conte%t one can understand the series of actions taken

by the Reserve Bank to raise policy rate to control inflation. &he repo rateswere raised ): times. &his is largely done in baby steps of +3 basis pointsevery time. Perhaps, a sharper increase earlier could have been attempted.!evertheless, the policy was in the right direction. 0uch of the increase inthe repo rate was a correction of the reduction in the repo rate done in theconte%t of the international financial crisis. In fact the policy rate hadremained negative in real terms in almost the entire period. &he signal for


12/26

reversal of the policy will be when headline inflation and core inflation showdefinite signs of decline.

Relative #eights of )roth and Inflation

'hat weight should be given to considerations of growth in policymaking has become a critical issue in our recent inflation e%perience, as therise in inflation also coincided with a period of declining growth. 'hile in+))) growth rate continued to remain high, the slow down started in+)))+, more particularly in the second half. &he manufacturing growthrate for the year as a whole was only +.3 per cent. However, inflationremained high and the process of tightening by monetary authoritiescontinued till end anuary +)+. &he repo rate reached its peak of /.3 per cent at that point in time. =ince then, there has been a process of easing.

&he repo rate was once reduced by 3 basis points to reach / per cent. &hecash reserve ratio which in my view is a more direct instrument has beenbrought down from 8 per cent to 9.+3 per cent. &hus since the beginning of +)+): there has been no tightening but only easing of the policy in smallsteps. &he need to balance different ob$ectives is inescapable. However,different arms of the government have special responsibility in relation toachievement of ob$ectives. &his is what is described as the Eassignmentrule’ in policy analysis. &hus among multiple ob$ectives faced by monetaryauthorities, control of inflation becomes the dominant ob$ective of monetarypolicy and takes precedence over other ob$ectives. However, it goes without

saying that all policy makers including monetary authorities must be forwardlooking and recognise the lags involved in the impact of policies. &hey mustknow when to tighten and when to loosen.

(ood Inflation and Monetary Policy

Cne factor that stands out prominently in the recent inflatione%perience in our country is the persistence of food inflation (6okarn, +))*(=rinivasan, +))*. Aood articles themselves are not one category> theycomprise of several categories of foodgrains, vegetables, fruits, milk, andeggs, meat and fish. 'hat we have seen in the last three years is foodinflation had remained high because of the spurt in the prices of onecategory of food articles or the other. Inflation in foodgrain prices startedalmost from the beginning of +/2, much before the failure of themonsoon of +2. But the failure of monsoon in +2 pushed up the pricesto very high levels beginning #ecember +2. It was at that point overallfood inflation e%ceeded + per cent. Aood inflation spurted again towards

12


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the end of +) because of the abnormal increase in the prices of vegetables. &he price of vegetables rose by :9 per cent in #ecember +)and 88 per cent in anuary +)). Both milk and eggs, meat and fish alsosaw consistently high price increases in +2 and +). 'hile inflation inthese commodities somewhat moderated in +)), they have shown a spurt

once again in +)+ (&able :*. 'hat are the ma$or factors behind the rise infood inflation< 'hile foodgrain production had been affected by thevagaries of monsoon, over the years, it had kept pace with the rise inpopulation. 'hile sudden spurts in the prices of foodgrains can bee%plained by weather related factors, the persistent high level of foodgrainprices is largely attributable to one structural factor, namely, the consistentincrease in the minimum support prices. &hese increases have rather beensharp in recent years. In the case of other food articles, while the growth inoutput has been reasonable (&able 9*, demand had outstripped supply. 'iththe rise in income, the per capita consumption of commodities such as

vegetables has been increasing at a rate much faster than the populationgrowth (&able 3*. It is obvious that food inflation can be controlled only byappropriate responses on the supply side. !ot only should the production of agriculture increase but also its composition must change with the changingtastes and demand patterns of the households. Hopefully, the marketsignals will find ade;uate response. Prices of most food articles in India areinsulated from world market prices. Cf course, in the case of foodgrains,we have a fundamental problem because of the operation of minimumsupport prices. Policy makers need to take due note of the impact of the

continuous increase in the minimum support prices on food inflation.Because of the minimum support price and openended procurement, foodstocks at the disposal of the public distribution system have enormouslyincreased. 4s of a recent date, stocks of rice and wheat e%ceeded 83 milliontonnes. &his has reduced the availability in the open market (see 4ppendi%for the impact of procurement prices on market prices*. &herefore, whenopen market prices rise, there must be a steady and $udicious release of foodgrains from the public stocks at prices below prevailing market prices inorder to bring down prices. Intervention in the foodgrain market by usingthe stocks has an important role to play in moderating increase in foodgrain

prices. However, the structural factor remains. In relation to foodgrain aswell as other food articles, there is also the demand pressure arising in therural areas through some of the schemes we have introduced such as06!R56=. It has been reported that there has been a distinct rise in ruralwages not only in nominal terms but also in real terms. In 4ugust +)), theyearonyear increase in nominal rural wages was ++ per cent> it has sincecome down to about )/ per cent in 4ugust +)+. In real terms, the

13


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Table 3: Behaviour of dierent Components of FoodInation

$ear Month


(ood)rains

9egetables Mil:

Eggs;Meat

< (ish

(oodArticle

s(ood

)rains9egetables Mil:

Eggs;Meat

< (ishA

, 1 1 2

3an )+/./ ))+.: )).: ))9.2 ))/.2 )9.:2 -.3- /.// +.8/

(eb )+/./ )/.: ))+. ))8.2 ))2.+ ):.3/ )-.98 2.8 -.+3

Mar )+3.2 ))9.3 ))+.) ))8.+ ))/.2 )).:+ :+.8/ /.3+ ).9

Ar )+-.: )+9.9 ))+.+ ))-.2 )+).3 )+.-3 9:./+ /.3) /.38

May )+8./ ):./ ))+. )++. )++.: ).:8 9).-) 8.)8 ).:)3une )+8.3 )9.: ))).3 )+.3 )+)./ /.92 +/.-+ +.8- 8.+8

3ul )+/.- )8+.9 ))+.3 ))/./ )+9./ ).:/ 93.3+ 9.83 :.29

Aug )+2.- )82.: )):.3 ))3. )+8.) ).) :3.88 3.:2 .+8

+e )+2.- )32. )):.- ))+./ )+3.3 8.)9 +:.+8 :.2: .-

4ct ):+./ )3:.: ))3.: )):.: )+8. 3.+: )+./2 :.82 9.8+

0ov )::. )99.3 ))8.: ))3.- )+3.+ :.+8 )).)3 3.+3 9.9+

Dec ):+.+ )++.8 ))8.: )):.8 )+).8 +.)8 9.3+ 8.+) +.9:

, 1 1 5

3an ):+.- )/.2 ))8.3 ))+.: ))2.2 :.: :.: 3.8+ +.+8

(eb ):9.) )2.9 ))-.9 ))8./ )++.3 9.)) ).+ 9./+ .2

Mar ):-. ))2.2 ))-./ ))-.- )+3.8 /./+ 9.-+ 3./ ).+2Ar ):2.3 ))9.9 ))2.: ))2.2 )+/.2 2.3/ /.9 8.:: ).-

May ):2. ))/.8 )+.) )+9.) ):.+ 2.8+ 2.:: -.+: ).-+

3une ):2.3 )+2.2 )+). )++.: ):.: ).+/ -.9) /.3+ ).92

3ul )9).: ):2./ )+).+ )+9.8 )::.9 2.-2 ):.2+ -.-: 9.//

Aug )9:.+ )93.) )+).- )+8.) ):9.9 ).9) )9.+2 -.++ 2.83

+e )9:.+ )3+.3 )++.+ )+8.: ):3./ ).9) 9.2 -.9/ )).2-

4ct )9-.: )-:.8 )+:. )+8.3 )9.: ).2+ ):.+9 8.8/ )).83

0ov )9/.: )//.: )+:.9 )+-.) )9).) )).3 :.:) 8.) 2./3

Dec )9/.9 )3:./ )+:.2 )+-. ):8.: )+.+3 +3.93 8.3: ))./

, 1 1 6

3an )92./ )92.3 )+9.3 )+8.2 ):-.+ )+./2 :-.+/ 8./- ):.(eb )3+. )+). )+9.- )+8./ ):9.) ):.:3 ).8 8.++ /.38

Mar )3+.) ))8.+ )::.2 )+-. ):3.8 )).+ :.2 ):.8- -.2

Ar )39.- )::.+ )::.: )+8.2 )9.) ).2 )8.9: )).-9 3./9

May )38.) )9.9 )::.2 )+-.+ )9)./ )+.: )/.:/ )).92 +.3

3une )3-.) )38. ):8.+ ):+.8 )93. )+.8+ +.2 )+.38 /.9+

3ul )3/.2 )-/.3 ):/.3 )9:.+ )3.9 )+.98 +-.8/ )9.+- )9.2:

Aug )8).) )/9.3 ):2.) )92.- )3:.- )+.3 +-.)3 )9.: )/.-++e )89.) )-.- )9+.- )3).9 )39.- )9.32 )).2: )8.-/ )2./-

14


15/26

4ct )88.2 )-2.: )98.9 )3.2 )3-./ ):.:) :.+/ )2.+ )2.+2

0ov )-:.8 )2)./ )3.- )8+.+ )89.- )-.8 )./8 ++.)+ +-.8+

Dec )--.: )/. )3). )89.: )89.8 )2.9- )-.9 +)./- +2.:-

Table 3: Continues

$ear Month


(ood)rains

9egetables Mil:

Eggs;Meat

< (ish(ood

Articles(ood

)rains9egetables Mil:

Eggs;Meat

< (ish

(oodArticle

s

, 1 !

1

3an )-2. )38./ )3-.8 )8-. )89.2 )2.92 9.// +8.32 :).8 +.)2

(eb )-3.: ):/.9 )8.: )-.: )8:.9 )3.:: )9.:/ +/.33 :9.:) +)./3

Mar )-+.+ ):+. )8-.+ )-+.) )8:.8 ):.+) ):.8 +9./- :3.3) +.83

Ar )-)./ )9:.2 )-.3 )-3.2 )8/./ )).3 /.: +-.2) :/.8) +.92

May )-+.+ )3.2 )-).2 )/3.) )-+.) ).:) -.9/ +/.:/ 93.3+ +).:-

3une )-:.9 )-3.) )-).2 )/9.: )-3.9 ).:/ )+.+9 +8.+) :/.22 +.2-3ul )-9.+ )-+. )-9.8 )//.+ )-/.+ 2.8: :.89 +8.8 :).9+ )/.9/

Aug )-9.9 )-8.+ )-8.3 )2.) )-8.- /.+8 9.3 +8./2 +8.22 )9.28

+e )-9. )/2.3 )--.) )28.) )-2.2 8.: )).) +9.)) +2.3+ )8.+2

4ct )-:.9 )2:.2 )--.+ )2+.+ )/.2 :./2 /.)9 +).9 +-.:- )9.89

0ov )-9.9 )/2.+ )--.2 )2+.2 )/).9 .98 ).:8 )/.3 )/.2: ).)9

Dec )-3.+ +9.3 )-/.- )28.+ )/2.9 ).)/ ::.8) )/.:9 )2.9+ )3.-

, 1 ! !

3an )-8.9 +8).) )-2.: )2:.+ )2+.9 ).93 88.3+ ):.-- )3.82 )8.8/

(eb )-/.+ )3/.: )/.9 )2+. )/).: ).83 )9.:/ )+.39 )+.-9 ).23

Mar )-3.8 )9:.: )-9.8 )23.9 )-2. ).2- /.38 9.9: ):.39 2.9)

Ar )-3.3 )98./ )-3.9 )23.3 )/8./ +.)3 +.+ +./- )).)9 ).88May )-8.- )92.2 )/+.9 )2-.: )/8.: +.8) .88 8.)) 8.32 /.+3

3une )--. )8:./ )2).- ++.3 )//./ +./ 8.93 )).3+ 2.// -.89

3ul )-/.8 )/3.9 )2:.9 +8.+ )2+./ +.3: -.-2 ).-- 2.38 /.)2

Aug )/.+ )22.9 )2:.) +2.2 )2:.- :.:: ):.)- 2.9) ).9+ 2.8+

+e )/./ +)8./ )23.: +)2.9 )2-.+ :.2) )9.9) ).+/ )).// 2.8+

4ct )/+.2 ++9.: )28.2 +)8.) )22.: 3.9/ )3.8/ )).)+ )+.9: ).)-

0ov )/+.9 +2.9 )2-.: +)9.2 )28.3 9.32 ).8/ ).2) )).9 /.:+

Dec )/+.) )3-.9 )2/.9 ++).2 )2.2 :.29 :9.33 )).+ ):.) .-2

, 1 ! ,

3an )/:.: )98.2 +).9 ++/.3 )2).) :.2) 9:.-9 )+.:: )/.+- .8/

(eb )/:.3 )8). +).3 +:.9 )2+.9 +.2- ).-) )).- +. 8.)+

Mar )/3.8 )2. +).: ++2.9 )2-.) 3.82 :+.32 )3.+2 )-.9 ).))

Ar )//.2 +:-.8 ++.2 ++2./ +-.+ -.89 8)./3 )3.8/ )-.39 ).2+

May )2.9 ++9.- +9.) +:).) +8.) -.-3 92.2 )).2 )-.): ).8:

3un )2:.: +93.2 +8. +:8.: +2.9 2.+) 3.)+ -.98 )8.82 ).2)

3ul )22./ +:.) +/.2 +9.9 +)+.9 ))./- +9.)) /.) )8.32 ).)-

Aug +-.8 +)2.3 +8. +:2.- +))./ )3.+) )./ 8.8/ )9.+ 2.:9

+e +)+. ++.+ +-.2 +9/.9 +):.) )-.+8 8.-: 8.93 ):.++ /.84ct +)).+ +-.8 +2.9 +99./ +)+.3 )3.9- -.93 8.:3 ):.+/ 8.8+

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0ov +)+.3 +8.2 +2.3 +93.9 +):.+ )8.3 ).)2 8.)/ )9.)2 /.3

able =" )roth in Production of 9egetables; (ruits;Mil:; Eggs and (ish -eteen ,11= and ,1!1

Commodity CA)R in >

"egetables 3.-+

Aruits -.3

0ilkD li;uid :.22

5ggs (!o.* 3.-8Aish (kg.* 9.9/

able ?" Per Caita Consumtion of 9egetables; Eggs

and (ish -eteen Different Rounds of 0++

CommodityCA)R %,11='!1& CA)R %!66@'11&

Rural rban All India Rural rban All India

"egetables 8.- 3.:/ 8.:: :.:9 :./ :.+2

5ggs (!o.* )).9 2.+: ).2) 2.+/ 3.8- /.+

Aish (kg* /.:- :.39 3./ +.8 ).8 +.:3

=ourceD !ational =ample =urvey CrganiFation (3, 33, 8) G 88 th round*

wage growth came down from )) per cent in 4ugust +)) to / per cent in+)+ (Reserve Bank of India, +)+*. 4ll these go to emphasise the need for much faster rate of growth in agricultural and allied activities, if inflation is toremain low. 4lso in relation to some food articles such as vegetables, there

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is an urgent need to improve the current marketing arrangements which arearchaic.

&o come back to monetary policy, while changes in monetary policycannot have a direct impact on food inflation, it can have a moderating

influence through containing overall demand pressures. 4t the same time, itmust be recognised that as the income elasticity for food is low, this channelof transmission may have only limited impact. However, as stressed earlier,if the persistence in food inflation leads to generalised inflation, monetarypolicy has to necessarily intervene (see 4ppendi% for the relationshipbetween Aood and !onfood inflation*.

Accetable Bevel of Inflation

'ith the persistence of food inflation and the structural factorscontributing towards such a rise, a ;uestion has been raised whether theacceptable level of inflation in the country must be raised upwards. =omepeople call it the Enew normal’. 4s mentioned earlier, the hakravartyommittee had thought of 9 per cent as the appropriate level of inflation.=ubse;uently, monetary authorities have acted more or less on theassumption that the comfortable level of inflation is in the region of 3 per cent. 'e have indicated earlier, why price stability is a desirable ob$ective.

4dvanced economies have an acceptable level of inflation in the region of +to : per cent. 0ost fast growing 4sian economies also work around this

number. It would be inappropriate for Indian authorities to raise theacceptable level of inflation. Cf course, inflation currently runs way aboveany acceptable level of inflation. It may take more than a year to bring itdown to 8 per cent. 5ven accepting foodgrain inflation is intractablebecause of policy issues as cereals have a weight of only 9 per cent in 'PI,five per cent as the acceptable level of overall inflation is still consistent withit. =ome people seem to argue that high growth warrants higher inflation.&his contention is not $ustified even by our historical record. In the threeyears when we grew at a rate higher than 2 per cent, the average inflationrate was much lower at 3.+ per cent. 'hat is needed is a much greater supply response to inflation. High levels of inflation undercut motivation for savings and divert investment into speculative channels. It would be best for the policy makers to work with an acceptable level of inflation of 3 per cent.

Cne may not fully agree with 0ilton Ariedman’s statement that?inflation is always and everywhere a monetary phenomenon@.!evertheless, monetary factors play a key role in the determination of inflation (see 4ppendi% on the relationship between 0oney and Prices*. &his

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is true even if supply side shocks trigger the initial increase in prices. =ector specific supply shocks e%plain at best only changes in relative prices. 'hilemonetary authorities may have multiple ob$ectives, they need to steer in aclear direction and prioritiFation of ob$ectives becomes essential. It has tocreate a hierarchy of ob$ectives. &he mandates of the central banks have

become wider. &his is inevitable with the increasing comple%ity of thesystem in which central banks operate. However, the primacy of pricestability as an ob$ective of monetary policy particularly in developingeconomies must be recogniFed. Cur own e%perience in the last three yearsis a clear reminder of this.

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Appendix I

+ome Econometric Relationshis

4gainst the background of the recent developments in inflation, anattempt has been made to test three relationships. Airst, an inverted

demand function for money was estimated to find out the relationshipbetween price on the one hand and money supply and income, on the other.=econd, an attempt was made to measure the e%tent of passthrough of food prices to nonfood manufacturing prices. &hird, an attempt was madeto measure the impact of changes in procurement prices of wheat and riceon their respective wholesale prices.

Money; outut and rices

How strong is the impact of money supply on prices< 4 visualinspection of the movements of money supply (0:* and inflation in 'PI showclose correspondence between the two series till +: (hart :*. &hereafter,the behaviour is not consistent. However to understand the full picture, weneed to bring in the impact of income. &o test more rigorously therelationship among these three variables, the following e;uation wasestimatedD

Pt J )Y t J +M t J :P t) Jϵt ()*

where P 1og of 'PI (average of weeks*

K 1og of 6#P at factor cost at +93 constant prices

0 1og of Broad 0oney i.e. 0: (outstanding on :)st 0arch*

&he coefficients of this model have the following interpretationsD

1ong run price elasticity of money +L() :*

1ong run price elasticity of output )L() :*

Income elasticity of money demand +

!

&he results of the estimates are presented in &able 8. I had earlier estimated a similar e;uation for the period )2-)+: (Rangara$an, +2*.&he results of the earlier study are reported along with the current resultswhich covered the period )2-)+)+.

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Chart 3: Inflation and Growth in M3


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able

Imact on Price of Money and Income

9ariables !62!',11@ !62!',1!,

1og (M :* .+8M .+8:M(.-* (.-+*

1og (GDP * .:2M .:):M(.)9* (.)3*

1og N'PI()*O .-M .899M(.)* (.2:*

onstant :.8MM +.+/9M

().:9* (.-+8*

Rs;uared .22 .22

1ongrun price elasticity of money ./- .-:2

1ongrun price elasticity of output ).:: ./-2

Income elasticity of money demand ).3: ).)2

!oteD M, MM, represent )Q and 3Q level of significance andthe numbers in brackets are robust standard errors.


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&he legitimacy of estimating the e;uations in the form presentedabove has been tested. 4ll the variables are found to be nonstationary of order ) but cointegrated. In the short run, a ) per cent increase in 0:increases 'PI by .+8 per cent. &he long run price elasticity of money is.-9. It may be noted that both the long run price elasticity of money andthe long run price elasticity output for the e%tended period are slightly lower

than the estimates made earlier for a shorter period. &he implicit incomeelasticity of demand for money is ).)2. 4 declining income elasticity of demand for money means a rising velocity of circulation which is whathappens when the financial sector grows. &he shifting nature of theparameter does pose a problem for policy makers. However, if the shift is ina narrow band, the policymakers can fi% the range of money supply growthwhich is consistent with noninflationary growth.

Pass'through of (ood Inflation

&he second relationship which we want to study is the e%tent of passthrough of food inflation to nonfood manufacturing inflation. If food inflationpersists long enough, it gets generaliFed because it results in an upwardpressure on wages and, therefore, on manufacturing inflation. However,inflation of nonfood manufactures is also dependent on other factors. 4partfrom demand and supply gaps, there is also the impact of imported inflationdue to increase in the prices of imported raw materials. In hart 9 we haveshown the ;uarterly inflation in food articles and nonfood manufactures.

&he visual inspection does not show a coherent pattern. &here could be alag in terms of the impact of food inflation on manufacturing inflation whichmay not be obvious from a visual inspection.

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Chart 4: Behaviour of Food Artiles and !on"Food #anufaturin$ Ination %&"o"&'


24/26

In order to test the relationship between nonfood manufacturinginflation with food inflation, we analyFed the ;uarterly Indices of both from+3 to +)+. 4ppropriate tests indicated that they are ointegrated or inother words there is a long run relationship between food and nonfoodmanufacturing inflation. 'e then proceeded to estimate three e;uationsusing the ;uarterly data for the period from +nd ;uarter of +3 to +nd ;uarter +)+.

!. Bn8#PI0(Mt ,.@2* F 1.=@,* Bn8#PI(At

%1.166& %1.1,1&

R, 1.6=

,. Bn8#PI0(Mt ,.?6* F 1.@6* Bn8#PI(At F 1.1=2** Bn8I0D/CrudePricet

% 1.16& %1.1,=& % 1.1,1&

R, 1.6?

@. Bn8#PI0(Mt 1.@@*** F 1.1=?*** Bn8#PI(At F

%1.!5& %1.1@&

1.1@@*Bn8I0D/CrudePricet F 1.5?* Bn8#PI0(Mt'!

%1.115& %1.15&

R,

1.66

'here

'PI!A0 uarterly 'PI of nonfood manufacturing

'PIA4 uarterly 'PI of food articles

I!#%rudePrice uarterly inde% of 6lobal rude oil price

!oteD "alues in the parenthesis are the respective =.5 of the coefficients

M, MM and MM indicate statistical significance at )Q, 3Q and )Qrespectively


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