Two mistakes holding Indian economy?

Mihir Sharma has this article in BS.

He says there are two mistakes which are holding Indian economy:

  1. Central bank should be looking to manage inflation expectations. What RBI instead is looking at is cost push inflation. We do not have any proper way of measuring inflation exp. The result is interest rates have moved up sharply which is hurting growth
  2. Government need not do anything to spark recovery. Only talking alone does the work.

Second one is fully true. Not sure about the first. I mean talking to anyone on the street the most cited complain is high inflation and people expecting prices to rise further. We may not have the best measures for inflation expectations but clearly it is all too visible.

What is more of a debate is what can central bank do when there are problems from supply side? And that too in food supply area. How does it lower inflation in such cases? Or rather can it do anything to lower inflation in such cases. As Gokarn in his recent speech says:

During the two years I have been with the RBI, persistent food inflation has been one of the critical challenges to monetary policy formulation. There is a view, entirely legitimate, that monetary policy has no role in dealing with food inflation. Policy actions should, instead, be triggered by some measure of core inflation. However, this argument weakens somewhat when we move from a scenario where food inflation episodes are transitory, or short-lived, to one in which they are persistent, as has been the case in recent years.

In the face of persistent food inflation, just as with any persistent supply shock, the appropriate response is seen to be to use monetary policy to prevent the spill-over from the shock into more broad-based or generalized inflationary pressures. In other words, in order to keep inflation under check, relative prices across categories of commodities have to change in favour of the ones facing the supply shock.

Sharma’s article is to suggest moving away from textbook thinking. Well, most economic textbook ideas never really apply in India given the huge diversity. And thus you have a problem as you do not know what the solutions are….

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One Response to “Two mistakes holding Indian economy?”

  1. PB Says:

    I think the implication is that inflation was due to external reasons. I haven’t read the article but if this is the implication then I completely agree with it. In hindsight, I think the RBI made a mistake by increasing rates.

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