Page 191 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes
Example: Until recently, Brazil had successfully lived with inflation by adopting a system
of inflation indexing or monetary correction in 1964. Inflation in Brazil, which had averaged
over 20 per cent per annum during the fifties, had not deterred its economic growth which in
real terms had been about 10 per cent per annum.
Inflation indexing has a popular appeal because for an individual the money value of his wages
and assets grows at a predictable rate as inflation goes on while the government supports the
scheme because it allows inflation to exist without much public protest. It must, however, be
stressed that instead of solving the problem of inflation, indexing allows inefficiency and
distortions in the economy to perpetuate.

Case Study Controlling Inflation without Hurting Growth

he expected spread of food price inflation in India to more industrial categories has
provoked a crescendo of calls for sharp monetary tightening. Such a response
Twould be appropriate if excess demand were driving inflation.

But the current high Wholesale Price Index (WPI) inflation follows prolonged cost shocks
and a period of very low inflation. This low base overstates inflation. Policy should rather
reduce inflationary expectations without hurting the supply response.

Supply Response
The supply response is especially important since India is in a catch-up growth phase.
Investment is occurring to relieve specific bottlenecks.

Data from India’s Central Statistical Organisation (CSO) shows that fixed investment has
remained above pre-crisis levels of 32 per cent of GDP. There is a sharp rise in the production
of capital goods. Continuing high investment implies there cannot be a large excess of
demand over capacity. Good growth and sales help spread manufacturing costs.
If productivity rises, the price-line can be held. A good monsoon after a bad one should see
a sharp jump in agricultural production and softening of food prices. Inflation in primary
articles will fall from this month onwards because of the base effect and manufactured
goods inflation from November.

But wages and commodity prices are pushing up costs. Sustained high food price inflation
raises wages, since food is still above 50 per cent of the average consumer basket. That
procurement prices have held steady this year, after excessive hikes in the past few years,
will provide some relief.
But over the longer term, structural measures, such as better infrastructure and empowering
more private initiatives, are required to improve agricultural supply response. That the
National Rural Employment Guarantee Scheme (NREGA) has raised rural wages is a good
thing, but the emphasis has been on employment and not productivity, although it has the
potential to raise both.
A wage rise exceeding that in agricultural productivity raises food prices. Or else rupee
appreciation is required to let wages rise without inflation. Prices normally are sticky
downwards. So, with monetary accommodation, a relative price change raises the general
price level. What goes up doesn’t readily come down except for commodities. But in India
administered prices impart an upward bias even for food and fuel.

Contd...

186 LOVELY PROFESSIONAL UNIVERSITY