Reining in Inflation in India: Options for a Developing Economy

Abstract:

This case study helps in analyzing both structural and sporadic causes of inflation and also helps in debating policy options available for the government to combat the same. While highlighting the heavy dependence of Indian agriculture on rainfall and the shortcomings of manufacturing sector (in terms of increasing supply as well as employment generation), this case dwells into the fiscal policy paradox that has been breeding inflation, instead of containing. The age old laws governing land and labour markets were severely criticized for the sorry state of manufacturing sector, but the government was unable to act due to political constraints.

On the contrary, it resorted to populist policies for employment generation to rural poor. These policies, as observed, resulted in income growth without corresponding output growth in goods or services. Dependency of the country on imports to meet energy needs also added to inflationary pressures.

Inflation was in control for most of the decade, between 2000 and 2010, in spite of high economic growth. But from 2010 it galloped beyond the thresh hold level of the Reserve Bank of India, forcing measures for monetary contraction. The Bank increased the interest rates by more than 350 basis points in less than 24 months. The rate hike was not welcomed by the industry as hike increased costs and discouraged investments in turn leading to declining output. However, economists observed that the central bank of India was acting in the way it should in the absence of any concrete measure from the government either to ease supply constraints or to curb demand.

Issues:

» Understand the causes of inflation, especially in a developing economy

» Analyze various types of inflation and respective consequences

» Debate the role of central bank and effectiveness of monetary policies in containing inflation

» Discuss the policy options available for the Government of India to ensure low inflation in the long run

Contents:

Keywords:

Inflation in India, Nature and Causes of Inflation in India, Structural Deficiencies, Supply Constraints, Demand Pressures, Populist Economic Policies, Monetary Policy, Fiscal Policy, Interest Rates, Government Deficits

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