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Inflation: what is to be done?

Inflation: what is to be done?
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First Published: Sun, Jun 22 2008. 11 39 PM IST

Illustration: Malay Karmakar / Mint
Illustration: Malay Karmakar / Mint
Updated: Sun, Jun 22 2008. 11 39 PM IST
Inflation is now at a 13-year high. Let’s face it: We live in a new inflationary era.
The real debate now is what should be done to ensure that high inflation does not do more damage. In an article we have published today, one of the world’s best macroeconomists provides a list of things that Asian central banks should do to battle a noxious combination of slower growth and higher inflation. Barry Eichengreen recommends higher interest rates, appreciating currencies and fiscal stimulus. Asia has not done enough on these fronts.
Illustration: Malay Karmakar / Mint
Eichengreen writes on Asia as a whole. His general idea is that higher interest rates and stronger currencies will get into the fight against inflation. The ensuing drop in demand can be met by government spending.
That’s a pretty sensible course of action. The only problem is that the Indian government has painted itself into a unique corner on the fiscal front. We already have one of the worst fiscal deficits in the world. There is little room now to spend our way out of the incipient slowdown. Further fiscal expansion at this point in time will be akin to flirting with huge trouble.
It is perhaps a good time to once again ask a question we have often asked in these columns before: What was the finance ministry thinking when it merrily went ahead with the farm loan waiver, the pay hike to government servants and tax cuts? The commitment to fiscal responsibility was ditched many months ago; the official fiscal numbers have been made to look good, thanks to creative accounting.
Defenders of the government may argue that inflation has taken most countries by surprise. That’s true. A large part of the spike in inflation is because the US Fed has pumped money into the world to prevent the credit crisis from worsening. But a smart government should have bought insurance against such nasty surprises, rather than frittering away record tax collections in all sorts of populist schemes.
The general rule is that a government should balance its budget over a business cycle. Good tax collections should be used in times of strong growth to keep the budget in surplus. Surpluses can be spent when there is a downturn in the economy.
What now? The government is in knots. The one sensible thing the finance ministry can do right now is to step aside and let the Reserve Bank of India try its best to bring the inflation beast to heel.
How should inflation be tackled? Write to us at views@livemint.com
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First Published: Sun, Jun 22 2008. 11 39 PM IST