With WPI inflation hitting a 42-month high at 7.57%, the government must rethink its strategy of managing inflation. Instead of kneejerk reactions, the UPA must assess what has gone wrong. The recent RBI credit policy suggests that after monetary tightening for nearly two years, this government is unable to control inflation. And that, too, after the Union Budget has indicated that the fiscal deficit is under control. The government has been meeting, or nearly meeting, its FRBM targets. All official statements would suggest that both monetary and fiscal policies have been tightened under the UPA?s regime. If this was indeed the case, then why has inflation reached such heights? Are global commodity prices the only villains of the piece?
The difficulty with the official positions on both fiscal and monetary policy is that they try to brush the real problem under the carpet. If we look at the true deficit that includes food, fertiliser and oil subsidies, then there has been a big increase, and fiscal policy has been expansionary. If we look beyond RBI?s pious speeches about the top priority being inflation control and look at how it has been pumping huge amounts of liquidity into the system, we can easily see that claims about monetary tightening are hollow. The difficulty with the present monetary policy framework has only been increasing over the last two years. This has now reached new dimensions, what with the impact the CRR hike will have on industrial growth, which is already seeing signs of slowdown. As inflation rises, persisting with the policy of a weak rupee has to run us into trouble. If the government requires RBI to keep intervening in forex markets and pumping liquidity into the system, which RBI is finding increasingly difficult to sterilise, it will lose even more degrees of freedom. No amount of price control measures will help if money supply is growing about 20% while GDP is growing below 10%. Even those economists who claim that Milton Friedman was wrong about inflation always and everywhere being a monetary phenomenon, say it in the context of some commodities? prices rising even while money supply growth is low. It is against the first principles of economics to think that you can have much higher money growth than is consistent with the real economy and not have inflation.
