Everyone has agreed that the new government’s number one priority is bringing down the rate of inflation. There is a standard confusion in popular parlance about the level of prices and the rate of inflation. The demand is always for bringing down prices. Even Edward Heath, when he won the British election in 1970, was excoriated for failing to ‘cut prices at a stroke’. He had only promised to cut the rate of inflation at a stroke. Again we hear that Modi should bring prices down. Perhaps, but for a start, he should bring down the rate of inflation.
There are people in the BJP who believe that Raghuram Rajan is choking off investment by using the rate of interest as an anti-inflation weapon. But a central banker has no other weapon; he has to play golf with one club. His predecessor RBI Governor had made it clear that he sees the inflation as a result of excess demand as indicated by the budget deficit. Bring down the deficit, he more or less explicitly said, and I will cut interest rates. The budget deficit has not been brought down whatever P Chidambaram’s window-dressing may say. The incoming FM will have to seize the bull by the horn, reveal the true numbers and make drastic cuts in expenditure for the remainder of FY15.
Of course, as Alfred Marshall said long ago, prices are determined by the two blades of a pair of scissors—demand and supply. The incoming PM has thought about the supply-side and had prepared a note for the last PM way back in 2011. There were measures to remove structural rigidities, improve marketing, warehousing, transport networks and release stocks of foodgrains in time. All that can be implemented. But the time-frame for the removal of rigidities to have an impact on the rate of inflation is ‘long and variable’, as Milton Friedman said about the effect of money supply on inflation.
Politically, the prices that matter are those that people encounter in their daily purchases. Economists have to learn from marketing experts and model repeat-purchasing, i.e. purchasing behaviour on the lines of frequency—daily, weekly, monthly purchases—and then the opportunistic buying as and when the time is ripe. It is vegetables which are bought daily—onions especially—which make the headlines and spell trouble. This has been known for some time and yet the UPA-2 failed to take precautionary measures to guard against onion-price-rise. It