Subir Roy: Old remains gold in fighting inflation

A perpetually divided profession (of economics) is of no use to anyone in finding a solution to the current economc scenario

The country’s economic managers cannot figure out why inflation persists despite the monetary tightening that has gone on for well over a year. Persistently high inflation is bad enough but raising interest rates to fight it is producing its major downside: bringing down growth. For whatever it is worth, India’s government economists can derive solace from the fact that central bankers across the world are also in a jam. Implicit in the decision by some of them to keep rates low despite inflation creeping up – and in the case of Brazil, actually cutting rates though inflation has reached a new high – is the realisation that monetary policy has not achieved what it was expected to.

 

There is despondency, if not desperation, in the air as the developed economies appear to be headed for a “double dip”. The inability of central bankers to either fully believe in their orthodoxy or jettison it is partly the result of economists being sharply divided among themselves. Some say, revisit the all-out attack on inflation in the US in the seventies which achieved its aim but brought in a recession. This viewpoint holds that inflation persists in India because the central bank has been too timid. Others prescribe the tools used to fight the Great Depression of the thirties to fight the Great Recession of 2009. They say the world is not yet out of the woods because a sufficiently large stimulus package has not been applied for long enough to restore demand and raise national income.

Amid this uncertainty among policy makers, it may be useful to go back to what I G Patel had to say. Perhaps the most distinguished economic administrator that independent India has known and an outstanding economist, IG, as he was called, had a view on both the division among economists and inflation.

Over two decades ago (in 1990), IG focused on this academic and ideological divide by observing that much of the controversy between “monetarists and Keynesians was merely shadow-boxing”. In reality, “an eclectic mix of compatible fiscal and monetary policies has been found necessary to keep money demands in line with the growth in production in all countries. Even so, avoidance of inflation without unacceptable rates of unemployment and the maintenance of external viability without contractionist pressures at home have eluded so far all but a few governments.” Whatever be the reasons for this, “a perpetually divided profession (of economics) is of no use to anyone” in finding a solution.

IG’s views on the root causes of inflation and its cure formulated nearly three decades ago (in 1983) remain remarkably valid. He said, “Most economists are agreed that inflationary pressures are generated by excess demand and/or by cost push impulses.” But his special insight was that “both these explanations and causes could also be subsumed under the common heading of the struggle for a larger share in the national product by one sector which is likely to be resisted by another sector”. Thus, “distributional causes are at the very heart of inflation”. Some of the additional demand for food that has fuelled the current inflationary episode has come in tandem with the massive rural employment guarantee programme begun a few years ago, transferring buying power to the very poor and raising their hitherto negligible share of the post-reform prosperity. 

He then took a dig at “that celebrated economic entity called the quantity theory of money. The popular and rather picturesque view is that inflation is caused by too much money chasing too few goods and scholars are not wanting who assign to changes in the quantity of money the pride of place in generating inflation”. But “there is no direct or mystical connection between the quantity of money and the general price level. Nor does the quantity of money change on its own. It changes as a result of other phenomena such as a budget deficit or foreign exchange surplus or expansion in bank credit; and it is these underlying phenomena which are sought to be captured when we speak of excess demand or cost-push or a struggle for a larger share of the national cake”. The “crux of most controversies about inflation” is that “unlike the monetarists, there are many economists – among whom I include myself – who hold that while controlling the supply of money may be necessary, it is not generally sufficient”.

He added, “While inflation will be prevented by putting a lid on money supply, the price in terms of unemployment, excess capacity and fixed investment foregone can be excessive.” The persistently high unemployment in the West and the slowdown in fixed investment in India today bear him out. Clarifying what he meant, he said, “The moral, of course, is not that we should, in the face of an increase in the budget deficit, allow money supply to increase and keep interest rates constant. The moral obviously is that where fiscal policy tends to create excess demand, it is no use trying to deal with it by monetary policy alone. Fiscal problems ought to be tackled primarily, if not exclusively, by fiscal policy.” And “if monetary policy is required to nip cost-push impulses in the bud, it will have to be not just ‘non-accommodating’ — it will have to be pretty savage indeed”.

Given the periodic drought-fuelled food price-led inflation in India, IG’s policy prescription was forthright. “The only solution when it comes to controlling inflationary pressures which arise from periodic shortages of basic commodities is to eliminate these shortages — either by producing more on an average, or by importing more while the former is being attempted.” He felt “inflation ought to be controlled not just by control of demand but by stimulating supplies. Indeed in the long run, the latter is the only acceptable solution…”

subirkry@gmail.com  

The author is researching a biography of I G Patel