The Reserve Bank of India is in the position of a robber who runs down the street crying, ‘Stop, thief!’ pointing ahead at others. The Indian public seems to be outraged by inflation more than anything, except perhaps corruption. But, outrage is an emotional malaise, a form of entertainment. It does not lead to anything good. This need not be controversial, because virtually no one seems to recognize that inflation is caused by the Reserve Bank of India, India’s central bank.
If the RBI did not expand the money supply, it is very likely that we would have had deflation. Prices would have fallen, year after year. But, from 1969 to 2013, inflation in India has averaged 7.7 percentage. This is unusually high. The Independent India has reached closer to the informal target of 4 to 5 percentage inflation only from 1999 to 2006, when the central bank was more serious about reining in inflation. Even though the RBI claims that it is “fighting inflation”, price stability was never the overriding motive of monetary policy in India.
For much of the UPA government’s rule in the past ten years, India has had extraordinarily high levels of inflation. Ironically, when an economist is at the helm of the nation, India’s inflation rate has not just been way above the informal target, but is also among the worst in its history. It has been so since 2006, and since then, it has never been within the acceptable range. But, with fuel and fertilizer subsidies, the rural employment guarantee scheme, and various welfare schemes of the UPA government, this is not in the least bit surprising.
Even though the UPA government blamed it on the rising food prices, this is a denial of the elementary principles of economics. Inflation is, everywhere, a general rise in prices. The price rise in a particular industry will not lead to a general rise in prices in the absence of expansion of money and credit. The money, after all, has to come from somewhere. It would not have happened without the government printing money, to spend on its pet policies.
But, this is by no means inevitable. Many western capitalistic democracies which had high rates of inflation in the past have brought down inflation to historically low levels in the past two decades by having an inflation targeting regime. But, for long, the various Indian governments, including the UPA government hid behind the excuse that inflation targeting is irrelevant in the Indian context.
The reasonable Indian economists and policy analysts did not deny that inflation targeting has worked in other parts of the world. They just denied that it could have worked here, in India. As a result, when the developed west has seen close to optimal performance for decades, India faces double digit inflation. It is not just the developed west, but even the other emerging countries have outperformed India in this arena. India’s inflation which was historically lower than that of other emerging countries is now twice of that the average of other emerging nations.
A report submitted by the RBI Deputy Governor Urjit Patel had argued that India’s central bank should have a formal inflation target, like in more civilized countries, and should try to meet its formal target. But, the RBI started taking serious steps to curb inflation only after Raghuram Rajan, a talented economist took charge as the governor. Not surprisingly, in the past three months, inflation has radically dropped. Recently, the finance minister P Chidambaram had assured that inflation targeting would become the government’s mandate. But, this probably would not happened if Raghuram Rajan had not pushed for it, even at the risk of a conflict with the UPA government which expects the RBI to have many conflicting goals at the same time.