Measuring the change. India should invest more to enhance the reliability of various socio-economic surveys

Inflation and growth

The possible trade-off between inflation and growth has a long history in economic literature. The Phillip’s curve has been analysed theoretically and empirically. Tobin called the Phillip’s curve a ‘cruel dilemma’ because it suggested that full employment was not compatible with price stability. The critical question flowing from these discussions on trade-off is whether cost-push factors can by themselves generate inflation. Tobin said at one place that inflation ‘is neither demand-pull nor cost-push or rather it is both’, even though he did not agree with Friedman’s extreme position that there would be no pure cost-push inflation.

In the current situation, it is sometimes argued that inflation will come down, if some part of the increase in crude prices is absorbed by the government. There may be a case for reducing the duties on petroleum products for the simple reason that one segment of the population should not bear excessive burden. The same consideration applies to food prices. But to think that it is a magic wand through which inflation can be avoided is wrong. If the additional burden borne by the government (through loss of revenue) is not offset by expenditures, the overall deficit will widen. The borrowing programme will increase and additional liquidity support may be required.

Concomitant decisions

Commenting on the increase in repo rate and a rise in CRR, some have commented that this is double whammy. No, these are concomitant decisions. Central banks cannot order interest rates. For a rise in the interest rate to stick, appropriate actions must be taken to contract liquidity. That is what the rise in CRR will do. In the absence of a rise in CRR, liquidity will have to be sucked by open market operations. As the RBI Governor Shaktikanta Das put it in his statement, “Liquidity conditions need to be modulated in line with the policy action and stance to ensure their full and efficient transmission to the rest of the economy.”

Inflation in India cannot be described just as ‘cost-push’. Abundance of liquidity has been an important factor. The April Monetary Policy statement talked of a liquidity overhang of the order of ₹8.5 lakh crore. Beyond a point, inflation itself can hinder growth. Negative real rates of interest on savings are not conducive to growth. If we want to control inflation, action on liquidity is very much needed with a concomitant rise in the interest rate on deposits and loans.

C. Rangarajan is a former Chairman of the Economic Advisory Council to the Prime Minister and a former Governor, Reserve Bank of India 

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