No one would dispute the fact that inflation, especially food inflation, is the most debilitating macroeconomic problem in India today. So, it was widely expected that the finance minister would include some measures in the budget to tackle rampant inflation. But how you control inflation depends on what you perceive to be its major causes, and also how you measure policy trade-offs. These matter, because if policymakers get it wrong, the “cure” can be worse than the disease.
One school of thought—known as “monetarist”—sees inflation as purely a monetary phenomenon, created by loose monetary and fiscal policies that allow too much money to chase too few goods. The remedy then is obvious: control money supply through higher interest rates and tighter credit policies, and by reducing the government’s monetized deficit.
It’s hard to find too many pure monetarists around nowadays. This is partly because reality contradicts the assumptions of fixed supply and constant velocity of money. But it is also partly because governments have finally discovered that they cannot control broader measures of money supply through direct approaches.
So, most economists and policymakers increasingly accept the Keynesian position—that inflation is the result of aggregate demand-supply imbalances, reflecting the increase of real expenditure over income in the short run. Therefore, inflation control requires intervention that will affect the real economy: investment, consumption and output.
Here, too, there are crucial differences between those who see inflation as “demand-pull”—determined by rapid increases in demand that cause the economy to “overheat”; and “cost-push”— driven by rising cost pressures that reflect problems in supply, particularly of important raw materials and intermediate goods.
If you believe the first is the more important, you will seek in the budget to reduce overheating through fiscal austerity measures such as cutting back on public spending. If you believe the second is more relevant, you will try to address supply bottlenecks, especially in sectors (such as food) that drive the overall high inflation rate. The latter would probably require increasing public spending in these areas to improve supply conditions and distribution networks.
This government has already indicated where it stands on this issue. The Prime Minister and the deputy chairman of the Planning Commission have made it clear that in their perception, high food inflation is because of “increased prosperity” in general and “the success of the government’s pro-poor schemes” in particular.
This may come as a surprise to the farmers who continue to suffer agrarian distress, or the workers whose real wages are eroded by price rise, or the majority of the workforce whose self-employment has become more fragile and less viable. But the perception of macroeconomic overheating is widespread among influential policymakers. And this is why the focus in this budget has been on fiscal consolidation and restrained public expenditure, even in the critical areas that will affect the supply of essential goods and services.
This is only likely to make their prices rise faster in the near future, even as it damages employment prospects because of the negative multiplier effects of such reduction in spending.
The alternative cost-push perspective would have led to a very different fiscal strategy. In particular, public expenditure on improving supply conditions and distribution, and on subsidies that restrain some elements of costs (such as for food and fuel), would have received primacy. This would have required more spending on making cultivation viable, and on the public distribution system for food to ensure affordable public provision that restricts trading margins and speculative activity. It would also have required reduction of taxes on petroleum goods so that rising international prices do not translate into significantly higher domestic petrol prices. Since oil is a universal intermediate, such a policy is critical for containing the overall price level.
The significance of choosing between these alternatives goes beyond economics. Inflation is ultimately all about income distribution, and this budget clearly has negative implications for distribution. Oil taxes have been maintained at high ad valorem rates that deliver more revenue as prices increase, and indirect taxes have been increased even as direct taxes have been reduced. So cost-push pressures on prices will continue, maybe even accelerate.
This is a counterproductive strategy: trying to control inflation through fiscal tightening that worsens employment prospects, while adding to cost pressures and not addressing the root cause of food inflation.
This approach may well lead to significant increases in social tensions and unrest. If the current turmoil in the Middle East is any guide, increasing inequalities of income distribution and continuing attacks on the living standards of ordinary people are more likely than ever to generate popular disaffection. The resulting instability can have all sorts of expected and unexpected effects. If so, we should all fasten our seat belts: the ride ahead for the Indian economy is going to be bumpy.
Jayati Ghosh is professor of economics at Jawaharlal Nehru University.
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