Inflation: Some facts

Inflation: Don't worry, be happy 
DEEPAK MOHANTY

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Notwithstanding episodes of double-digit inflation, India has been a moderate-inflation country and the average inflation has come down over the last 15 years.

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The new series on WPI is of particular importance. Considering the data for the past five years, 2005-06 to 2009-10, it is seen that there is not much difference in average inflation rate between the new series and the old series which is about 5.5 per cent (see Table).
Going by the current experience of 5-6 months of double digit inflation, one can trace nine such episodes in the last 56 years. Of these nine episodes, double digit inflation lasting beyond a year occurred on five occasions.
The most prolonged one lasted for 30 months during October 1972 to March 1975. The last such high inflation was in the mid-1990s which lasted 15 months between March 1994 and May 1995. The Reserve Bank responded to the phases of high inflation through available policy instruments.
Notwithstanding these episodes of double digit inflation, it is important to recognise that India has been a moderate inflation country and the average inflation has come down over the last 15 years.


For the 56-year period from 1953-54 to 2009-10, the monthly annual average inflation is around 6.7 per cent. There has particularly been a perceptible drop in the average WPI inflation to about 5.1 per cent in the last decade during 2001-02 to 2009-10.
Inflation has strayed from its long-term path from time to time. The upward spikes in inflation from its trend are explained by significant supply shocks.
Generally, high inflation periods were coincident with episodes of oil price surge and drought conditions.
The following major conclusions may be drawn from our experience with inflation over the last 60 years.
First, the new series of WPI inflation marks a major change in terms of scope and coverage of commodities and is more representative of the underlying economic structure.
As per the new series, the manufactured products inflation is lower than what was seen on the basis of the old series.
The food price inflation, on the other hand, is higher than what was seen on the basis of the old series.
Food prices
The high level of food prices is indeed a matter of concern as the prices of protein-based items, which have a higher share in the consumption basket, are showing larger increases.
Moreover, there is continuing shortage of food items such as pulses and edible oils. If the supply response doesn't improve, there is a risk that food price inflation could acquire a structural character.
Second, historical data show that India is a moderate inflation country. But there have been phases of sharp spikes in inflation emanating from war, drought and commodity price shocks.
Supply shocks when accompanied by demand pressures further amplified inflationary pressures. But the inflation rate has reverted to its trend following policy response and improved supply conditions.
In the periods of high inflation, monetary policy responded with a combination of available policy instruments through changes in policy interest rates, cash reserve ratio (CRR), statutory liquidity ratio (SLR), and in the earlier regime through increases in administered interest rates and credit control.
Reduced volatility
Third, the volatility as well as incidence and duration of double digit inflation has reduced over time.
Inflation control since the mid-1990s has been particularly successful which can be attributed to wide ranging reforms which have improved the macro-policy framework and eased supply constraints.
Fourth, the long-run inflation trend is determined by non-agricultural GDP and money supply. Increase in money supply unaccompanied by a commensurate increase in non-agricultural GDP is potentially inflationary.
Finally, with the reduction in average inflation and inflation volatility, since the mid-1990s, tolerance for high inflation has come down. The moderation of inflation trend has had several beneficial effects in terms of lower nominal interest rate and high GDP growth rate.
Given the remarkable stability in the inflation rate since the mid-1990s, it is important to persevere with appropriate policy responses so that the high inflation seen in the recent months does not get entrenched.
Even if the trigger for inflation is from supply side, its persistence necessitates monetary policy responses to bring the inflation rate back to its trend and anchor inflationary expectations.
(The author is Executive Director, RBI. The assistance provided by O. P. Mall, Abhiman Das and Binod B. Bhoi is acknowledged.)

Source:
http://www.thehindubusinessline.com/2010/10/06/stories/2010100650820900.htm