The Indian Economy Blog

May 9, 2008

Guest Post: Fighting Inflation The Wrong Way

V Anantha Nageswaran

A table of inflation rates in many countries around the world is beginning to reveal a disturbing picture. The lowest rate is found in Germany – at 3.0%. Many emerging countries that seem to be doing a truthful job are reporting inflation rates in excess of 10% and some in excess of 20%. Others, either out of deliberate intent or methodological deficiencies, report far less. India belongs to the latter category.

Inflation is the world’s number one problem. Governments are pretending to respond. In the UK, Mr. Gordon Brown wants to assemble experts to debate solutions. The Indian finance minister says that western nations are diverting land for producing expensive bio-fuels to replace the expensive crude oil. Surely, that is part of the problem. But that does not explain the jump in the price of rice. Rice is not diverted to bio-fuel production.

In India, the response has been to reduce import duties, impose export caps and accuse manufacturers and distributors of collusion and cartel-like behaviour. Different ministers speak in different voices. Together, these pronouncements do not constitute a policy whole.

In simple terms, prices reflect the balance of supply and demand of something. When prices go up, it is a reflection – and not a consequence – of supply going down or of demand going up or both. When it happens for just one or few commodities, it is possible to blame middle-men of hoarding or manufacturers of cartel-like behaviour. When it happens in many commodities, it is futile to blame one industry or a few producers.

Usually, the source lies in some policy measures and their implementation. To make it clear, we are not dismissing the importance of factors like climate change, diversion of land for production of bio-fuels and more importantly, stagnation or even outright decline in agricultural productivity in countries like India and China. Again, they explain inflation in food and agriculture commodities. These factors do not explain inflation in crude oil and copper, for example.

If we have to identify a single or the most important explanation for the recent development in prices of many commodities, the answer lies in examining the behaviour of global central banks.

Of course, in any broad-brush analysis or conclusions, there is the risk that we miss the exceptions who behaved differently and correctly. For example, within the constraints imposed by the political system, Reserve Bank of India has done a very good job of trying to shield the Indian economy from the cycles of boom and bust. Similarly, if the Australian and New Zealand economies still face the risk of boom and bust, it is not because of their central banks but in spite of their best efforts.
The bulk of the blame has to be assigned to the American Federal Reserve and the People’s Bank of China. In the case of China as in the case of India and in many other developing countries, the central bank is not independent. It is subject to political influence. The Federal Reserve Board of America is, in some ways, a similar predicament. It is subject to the oversight and pulls and pressures of the democratically elected Congress members. Further, since it was founded by banks actually, it ends up coming to the rescue of banks sometimes to the detriment of the public.

In 2001-2003, it cut the Federal funds rate to 1.0%. It thus rescued the economy from the collapse of the technology bubble in 2000. Thus, it replaced the stock market bubble with a housing bubble. When the housing bubble appeared to be weakening, it refused to tighten regulations and allowed it to continue. Too many loans were made to people who should not have been lent. That is the root cause of the present problem.

In order to address the resulting loan defaults, stress on banks and their balance sheets, the Federal Reserve has allowed banks to borrow at cheap rates from it. Money is available to banks in the open market but at higher cost. Some of the banks might not have survived. But, that would have also left a lesson for other banks that they would not have forgotten for a long time. Excessive risk-taking would have been curbed. Instead, the cheap money is perhaps being channelled into speculation on commodities prices. After all, banks are not going to create more mortgage loans at least for quite some time.

Somewhat different has been the behaviour of China but it achieves the same result. China has kept its currency cheap. Keeping the currency cheap requires interest rates to remain low, in comparison to other countries but also in relation to economic growth. China has done that. Low interest rates means capital is plenty. So, capital-intensive growth has flourished. That has placed tremendous demand on resources worldwide such as crude oil, coal, steel and other industrial metals. It continues to import rising quantities of iron ore, copper and crude oil. Incidentally, it has also led to China supporting many tyrannical regimes in Africa including that of Zimbabwe. Recently, it sent a shipment of arms to Zimbabwe but faced an avalanche of protest and had to recall that shipment.

Perhaps, it is possible that American banks know that there won’t be any change in China’s demand for commodities in the near future, at least until the end of the Olympics. China may be reluctant to change course fearing unknown and uncertain consequences. If so, it argues for further rise in the price of commodities. Both their behaviour and bets might be feeding off each other. That is not good news for the rest of the world.

After all, we cannot influence the Federal Reserve. So, how should policymakers respond? Unfortunately, the answer is that they should respond differently from what they have done until now. Banning exports of agricultural commodities exposes the hollowness of farmer-friendly policies. Farmers should be allowed, with appropriate guidance, to sell to the highest bidder – local or global – and derive the maximum gains from the global shortage. Such a price signal would also encourage productivity improvement in farmland and hence boost crop production. More land would be brought under cultivation. At the same time, poor households – rural or urban – could be directly subsidised with cash transfer to be able to pay the higher price.

The same principle can be extended to the price of hydrocarbon products such as petrol, cooking gas, diesel and kerosene. Consumers and producers should receive the price signal. Without that, their respective behaviours would not change and shortages or glut would persist.

At the same time, since supply of food and other commodities would take time to respond to price signals, central banks should be allowed to restrain demand in the short-run with tight monetary policy. That means higher cash reserve ratio or higher interest rates or both. That might be unpopular or politically unacceptable. But, effective medicines never taste sweet. Only placebos do.

The chances of such sound policies being pursued are close to nil particularly as many democratic governments, including India, approach elections soon. Authoritarian governments do not care much for public opinion.

Given such a low chance for sound economic decision-making, prospects for a sustained decline in inflation should be judged remote. That is not good news as it is a stealth tax on the public and erodes their purchasing power. Consequently, it reduces affordability for many assets. As demand drops, inflation affects revenues for companies and squeezes margins through cost pressures. That does not augur well for the stock market.

The stock market in India has performed well in recent times. Many other global markets have staged a similar recovery. That is due to misplaced optimism on the American economy. As discussed above, right policies would be missing and hence the anticipated quick economic turnaround in America would be elusive. Consequently, risky assets globally would retrace their recent gains. Therefore, Indian stocks would fail to build on their recent gains. On the other hand, the likelihood of continued high global and local inflation would result in a resumption of the uptrend in gold price that has been recently disrupted. Therefore, investors who do not expect inflation to recede know exactly what they should be selling and what they should be buying.


  1. “Inflation is the world’s number one problem.” – a statement possible only on a blog such as this!

    Comment by Perakath — May 9, 2008 @ 1:48 pm

  2. Perakath,
    You could have done better. Instead commenting on one sentence, you could have expressed your views.

    V Anantha,

    “Banning exports of agricultural commodities exposes the hollowness of farmer-friendly policies. Farmers should be allowed, with appropriate guidance, to sell to the highest bidder – local or global – and derive the maximum gains from the global shortage”

    To me ban on exports of essential commodities is a must at such a stage of global food crisis. If you lift the ban, you will be only left with more shortage within the country. The need now is to first address the local issue & scarcity.
    As far as prices are concerned, helping farmers to sell to highest bidder to derive maximum gain will have following effects;
    1. Rates offered in International market will always be more & lucrative. With due regards, but this will just abet farmers in exporting commodities then offering the same in local market.
    2. Moreover you always have the danger of cartels who would step in or a middle-man with dangerous motive of “derive-the-maximum-gains-from the-global-shortage”

    Comment by Gorbachev — May 9, 2008 @ 3:29 pm

  3. Gorbachev: Yes that’s true, but I don’t think I know enough about inflation or economics in general to be able to make valid comments. It just struck me as mildly amusing that only an economist would be likely to answer ‘inflation’ when asked to name the single largest problem the world faces today. On the other hand, this is a blog about economics so it’s perfectly natural that such a statement be found here. That was the reasoning behind my remark.

    As for inflation itself, I’m not sure what to believe about it. It started off with “price rise” stories in the newspapers and now inflation has become a buzzword. As if it’s something new. Prices are bound to rise and they’re accompanied by a corresponding drop in the value of money, right? Things cost more now than they used to, we all know that.

    I read conflicting opinions from economists (take your own disagreement with Mr Anantha Nageswaran in your comment), but one common thread is that they all seem to know just what to do to fix the problem. If it’s so obvious, why is it not done? Are political considerations the sole cause for the government not doing what is correctly required to control inflation?

    Or are there other reasons too? I’m sure the measures suggested in this article to control inflation will have far-reaching side consequences that can be criticised as being too focused on inflation while disregarding [insert economic term here]. However I’m not in a position to say what those other consequences may be. Perhaps the government is doing what it feels is right, given holistic considerations as well as political restraints. I’d be happy to hear any points regarding this.

    Comment by Perakath — May 9, 2008 @ 7:03 pm

  4. Comment on the following statement:
    “The Indian finance minister says that western nations are diverting land for producing expensive bio-fuels to replace the expensive crude oil. Surely, that is part of the problem. But that does not explain the jump in the price of rice. Rice is not diverted to bio-fuel production.”

    You are right rice is not used to produce bio-fuel. However, because of bio-fuel more corn is being planted. It is taking up more acre-age leaving less for other crops. As a result less land is available for rice, wheat etc.

    To burn (as in use as fuel) food when so many people are starving is morally and ethically incorrect. Come to think of it when did you hear about riots because of food.

    We have to stop burning food. Period.

    Comment by Abhilash Kushwaha — May 9, 2008 @ 7:39 pm

  5. I don’t like to criticize other nations for their policies. They are all sovereign nations and should be able to do what they please. If US and Europe want to convert food into ethanol, that’s their choice. What we should do is stop blaming other nations for our problems. If we grew more food ourselves, we would not be at the mercy of other nations. Successive governments have paid lip service to developing agriculture. Now it is time for them to be voted out of office. The world is cruel and competitive place. It’s time that we grow up and deal with reality of scarce resources and increasing competition. We, the educated elite, should stop accepting government’s excuses for failure and stop consenting to their anti-market policies.

    Comment by Alex — May 9, 2008 @ 8:49 pm

  6. Abhilash,

    But according to UN Food and Agriculture Organization, global rice production has increased by 1.8% this year, up from 1% last year. So I don’t think the Australian droughts or bio-fuels alone can explain the whole picture, especially given the fact that India produces it’s own rice requirements (if I remember correctly).

    The other explanation I can think of is that because the price of wheat has gone up due to bio-fuels, supply shortages more and more people are consuming rice as a substitute for bread, and hence there’s big increase in demand for rice which is driving up prices.

    But as a whole, I think you’d miss the picture if you ignore the impact of low interest rates and the role of ill-managed monetary policy like this post somewhat suggests.

    Countries like India (and Sri Lanka where I come from) have more or less pegged our currencies to the US Dollar, and what has happened recently is that the value of the dollar has declined rapidly thanks to the increased money printing by the FED, and we end up importing US inflation (in addition to creating our own inflation through a discount window, resulting in Sri Lanka’s case, an inflation rate close to 30%!)

    Since most commodities, including foodstuff are priced in Dollars the decline of the dollar means that prices in terms of dollars goes up, and because we are pegged to the USD, in terms of rupees as well.

    I have put down more thoughts here .

    Comment by Deane — May 10, 2008 @ 12:34 pm

  7. I agree with the comment/surprise that inflation is deemed the world’s number one problem. It is arguable. Even as categories of economic problems go, it is only arguably the world’s important problem.

    As Deane writes, the purpose of the article is to make the reader focus on, what I think, is the common link/thread that connects increases in prices in all commodities and that is monetary policy that assumed inflation to be conquered.

    Precisely that complacency brought it back.

    Sure, there are costs/side-effects to any solution in economics. But, we won’t be arriving at the right one or helping governments arrive at the right mix if we don’t debate them.

    Thanks for all the comments.

    Comment by Anantha Nageswaran — May 10, 2008 @ 1:21 pm

  8. you can sell only what you grow…the idea of selling directly to the highest bidder seems nice in that light…but recently we have seen a lot of super markets coming up with their own fruits and vegies…so wouldn’t it be better,if the government decides to create a more friendly environment for them? it can also urge them to produce more bio-foods instead of GM stuff…

    Comment by vishesh — May 10, 2008 @ 2:01 pm

  9. One of the most lucid primers on inflation -and indeed the global economy- for lay people like me. I still have some questions and an opinion.

    Ananth, you say: “More land would be brought under cultivation. At the same time, poor households – rural or urban – could be directly subsidised with cash transfer to be able to pay the higher price…. The same principle can be extended to the price of hydrocarbon products such as petrol, cooking gas, diesel and kerosene.”

    Would this not be allowing inflation to actually rise and then locally abate it? Is it possible for higher profits from food exports to cross subsidise higher petro prices? What’s so awful about a spell of worldwide recession? Sanity and the environment may have a much needed break.

    Finally, as a lay person I venture an opinion as follows: India’s predicament is the inability to deliver services and good intentions without massive leakages. The Indian experiment has been to somehow constantly grow at 10% and cross-subsidise leaks. This is now being proved unworkable. Indian policy makers’ fear should be not that they cannot think up a sound remedy but they cannot have their will realised in the ground.

    Reforms began at the wrong end. We needed to hone a delivery mechanism.That needs great vision and leadership rather than the Bretton Woods apprenticeships that our PM, FM and the Chairman of the Planning Commission have.

    Thanks again Ananth for laying bare the problem, even if your solution is unlikely to fly.



    Comment by D V Sridharan — May 10, 2008 @ 2:15 pm

  10. “Many emerging countries that seem to be doing a truthful job are reporting inflation rates in excess of 10% and some in excess of 20%. Others, either out of deliberate intent or methodological deficiencies, report far less. India belongs to the latter category.”

    V Anantha, great writeup. I would like to know what India’s correct inflation rate is at the moment.

    Comment by Nikhil Nayak — May 10, 2008 @ 6:36 pm

  11. ‘central banks should be allowed to restrain demand in the short-run with tight monetary policy’

    I am not sure how much effect monetary policy will have on food grain prices. After all, one major problem we have here is the lack of enough institutional credit to the producers (here farmers). So I guess monetary policies can only impact more organized industries like FMCG, automobiles, steel etc.

    Another effect that you missed is the effect of wage inflation in many emerging markets in recent years.

    Incidentally one more reason why oil (and many commodities, including metals) continue to rise is their trading in dollars. Whenever the dollar depreciates (due to a possible downturn in the American economy) one way an investor hedges his risk is to trade more in the futures market for these items. The idea is to offset the risk in dollar depreciation with an that of an appreciating asset (oil, wheat, rice, metals…).

    If you’re an investor, this is sound investment strategy. If you’re not, you end up paying more for a living.

    Comment by photonman — May 10, 2008 @ 10:24 pm

  12. Is there a stagflation in the agricultural sector?
    Production (data says) is adequate. There is no food shortage. This is a view from the point of view of the consumer-the demand.

    What about the supply side view-the production side? Are they (farmers) earning enough to sustain themselves and their family?

    And inflation is caused basically by the supply-demand mismatch.(economists enjoy saying this over and over again) But what forces constitute demand and supply? One is often not very clear- do we look at aggregate or seggregated data?

    Is there only an economic side to inflation? What about the political and social side?

    Who benefits from inflation? Fast consumer goods-sold fast-since money is falling in value-they earn more-debtors earn more since the roi are low.

    Also media role in enhancing inflationary expectations.

    And, i agree that inflation is being fought the wrong way. WPI needs to be restructured.

    Comment by Alex M Thomas — May 10, 2008 @ 11:42 pm

  13. Alex, though I have not seen stagflation used for the food crisis, it would be an interestingly apt description if you discount the unemployment aspect since we have food supply not growing as much vis a vis demand due to droughts, land diversion for bio fuels etc. Thus in terms of demand supply ratios, my guess would be its constant while at the same time inflation is rampant. Though I would call it stagflation only in a lighter vein. As for your question on whats driving this, a lot of economists including Anantha believe (or so is my understanding) that due to a lot of cheap money available for investment and lesser opportunities, investors are hedging on food. Thus even if your supply and demand is the same in real terms, speculative demand has risen due to this cheap money and thus inflation.

    btw, another factor which is probably marginal but still affects things is the falling dollar. Since oil is rising as the dollar falls, the cost of food production and processing also goes up.

    Comment by Ardy — May 11, 2008 @ 10:21 am

  14. Let’s try to supplement this discussion by adding a factual perspective to this:

    1) Correlation of commodity prices with derivatives:
    Futures on commodities has never been proven to have any statistically significant correlation or empirical evidence with causing commodity spot price volatility. Analysis of matured global futures markets by economist clearly demonstrated this over and over. In the 5-6 decades, there were numerous times when cheap-money was at global FII’s disposal and it would have been immediately deployed in futures-mkts, if they think they can drum-up the forward prices by pumping volume. From my own exposure to working on derivative models including BSM, Random-walk (brownian) and multi-factor models, this was never an assumption or a stat-significant signal in investment community.

    2) Productivity (Yield) scenario:
    It is embarassing to our nation as a whole to keep delivering the pathetic yields. For Milled Rice, india’s yield stand at 3.2 MT/Hectare. Compare that with 6.1 MT/H of china and 8.25 MT/H of US. For Corn, india’s yield stand at 2 MT/Hectare. Compare that with 5 MT/H of china and 9.75 MT/H of US. Agriculture ministry’s focus-area should be in stopping the pep-talk on saviourship and work on improving the yields.

    3) Inflation Measurement:
    Here again, India is one country which still uses Wholesale level WPI instead of CPI.Even CPI is measured in 3 separate demographics (industrial workers, Urban, Rural).The basket constituents and weights are made up for our convenience and not representative of consumer spend distribution. For Housing, the weightage in the basket is currently 8.67 which is artificially low. First order of business for RBI, planning-commission and fin-min: FIX THIS.

    4) Open mkts for Agri products:
    The political mindset always tends to be over-defensive and not risk thier prospects. They limit the access of global mkts. to farmers when high-prices/tight-supplies condition arise globally for any commodity thereby thinking that they ensured common-man’s need is taken care of. From a political standpoint, it’s normal during these times to remove/bring-down the import-duties and increase export-duties. I would imagine that a country that’s a purist in terms of International-trade and capitalism (allocate capital and resources into products that it is efficient at and rely on importing the remaining) would have choked and got annihilated with remaining countries practicing hybrid-from of international trade blocking the exports of things that they’re good at.

    This is the political reality: In normal times, a country wouldn’t mind maintaining high-price-level for a commodity by creating MSP (Minimum supported price), taking subsidy-loss, regulating exports, blocking imports to protect domestic industry and ensuring supplies to meet domestic demand. In volatile periods, they tend to relax import duties, block/tighten exports and subsidize procurement.

    5) OIL:Balance of priorities for greater good:
    Economic strategists in india need to balance the 1) need to discourage discretionary-oil consumption by keeping prices high 2) the need to keep our industry at a same level-playing-field as our global counterparts by not having this input cost’s price-level higher, there by giving our industry an inherent and continuous disadvantage in pricing thier products in global-mkts. (note: Our oil price is artificiailly high and govt’s net is surplus in oil pricing if we take into account the subsidization burden and ~30% excise-tax mixed into pricing.

    6) Burning Corn/Sugarcane for Ethanol:
    2.15 billion bushels of Corn is being burnt annually to fetch around 6 billion gallons of ethanol. 500 MT of sugarcane is being burnt annually to produce another 6 billion gallons.Industry knows that this policy of subsidizing ‘ethanol from corn/sugarcane’ is mis-guided and un-sustainable. US already is seeing high prices for corn-feed that’s causing high price-levels for milk and meat. An exception exist for brazil to justify it’s ethanol as sugarcane is a huge surplus in brazil. But, this is a transitionary period before highly-efficient cellulostic ethanol gets mainstreamed and other alternative fuel-sources get in. At 125$/barrel, lot of other un-economical energy production sources suddenly looks (electric car breaks even at around 65-70$) promising. Industry do know the limits of these alternative fuels (fuel cell) and the fact that it would take time to get commoditized and get to a scale to replace oil.

    Comment by Siva Moturi — May 11, 2008 @ 10:24 am

  15. Ajay Shah argues..

    Comment by Ardy — May 11, 2008 @ 10:43 am

  16. Ardy,

    Most of the reasons provided by economists tend to lie on the ‘monetary’ side. Though i do think that monetary factors heighten inflationary expectation. (I am not sure of the magnitude of impact inflationary expectations has on ‘inflation’)

    My question is: what about the real sector? Production crisis, low productivity in agriculture etc.


    Interesting and insightful facts.

    Also, WPI does not include services and land.

    Comment by Alex M Thomas — May 11, 2008 @ 12:54 pm

  17. the RBI is allowing arbitrage, the best option is to allow the rupee to appreciate. the CRR is a blunt instrument. Banning exports along with other fiscal measures are symbolic, might have little impact. Remove them and let the rupee appreciate. Exports look unattractive, local prices might decrease.
    but no, the IT industry & other export oriented industries (esp textiles) will go crying to the govt asking the rupee to remain above 39. The commerce ministry will pressurise the RBI. So for a couple of industries, we all have to suffer. Such is india.

    Comment by vatsan — May 11, 2008 @ 4:23 pm

  18. Understanding Inflation

    1. The real explanation of Inflation is, it is the “rate” at which rich gets richer and poor becomes poorer.

    2. World is following Keynesian currency system for past 50 or so years, Keynesian economics works only when there is unlimited availability of resources, when a resource crunch happens Keynesian fiat currency system will fail, this is obvious now. We need an alternate system.

    3. Can we imagine engineers using a measuring scale that changes length every day? using currency that changes value every day is equally foolish.

    4. Wealth is nothing but energy and humans derive energy for sustaining life from food. Hence if currency is measure of wealth then only possible fixed value currency system is to use food grains as currency. Use of any other substance as currency will need assurance of currency “value” by “issuer” through redemption obligation.

    5. Gold does not have intrinsic energy, hence to realize value needs one more exchange, hence gold cannot be used as valid currency unless someone assures value through redemption obligation. Using gold as currency was the longest running “scam” in the world.

    6. Indian Economy till 1970 was using food grains as currency at village level. This was a tried and tested economic system that has worked for centuries.

    7. When using a real currency (eg. food grains as currency) in a free market economic system, where buyers and sellers exchange products and services voluntarily, it will be extremely difficult to become supper rich, without using force and use of force is obviously immoral.

    8. When we abolished slavery, caste system etc, we re-introduced much more convenient system of fiat currency which serves the same purpose.

    9. Fiat currency inflation is one of the last bastions of human-to-human exploitation. Will we be able to overcome this last hurdle and usher in an era of global prosperity?

    10. Yes it will happen…….

    Comment by Krish — May 11, 2008 @ 9:13 pm

  19. Siva,

    Quick question: You say that ‘Futures on commodities has never been proven to have any statistically significant correlation or empirical evidence with causing commodity spot price volatility’.

    What’s the time horizon on which you’re measuring volatility? It’s well-known that futures trading will not change long-term trends in volatility – as you point out. This is presumably because of some sort of equilibration. But what about short-term trends?

    Moreover, in economics, the models that we work with are hardly as sacrosanct as the laws of nature – they are phenomenological. So just because there is no historical basis for futures trading to increase spot volatility, there is no reason why we should rule it out now; people keep changing their trading strategies and learn from (and sometimes even forget) their past. I guess that’s what makes economics an ‘evergreen’ area.

    Comment by photonman — May 11, 2008 @ 9:57 pm

  20. @Siva
    “2) Productivity (Yield) scenario:
    It is embarassing to our nation as a whole to keep delivering the pathetic yields. For Milled Rice, india’s yield stand at 3.2 MT/Hectare. Compare that with 6.1 MT/H of china and 8.25 MT/H of US. For Corn, india’s yield stand at 2 MT/Hectare. Compare that with 5 MT/H of china and 9.75 MT/H of US. Agriculture ministry’s focus-area should be in stopping the pep-talk on saviourship and work on improving the yields.”

    Purpose of Agriculture is to store solar energy.
    In USA it take >10 calories of fossil fuel energy input (fertilizers, pesticides, farm mechanization) to produce 1 calorie of food.

    Comment by Krish — May 12, 2008 @ 4:30 am

  21. Nice analysis, a couple of comments though….Not all of FED’s policies are targeted at helping the banks….This is the time when the major banks in the US tighten screws on lending credit to the customers and in the process raise the APR on the existing balances which increases the misery of the households…FED has intervened to make sure that APR on the existing balances does not increase (with exceptions)…This might help the households quite a bit (though one time policies like the economic stimulus act might go a waste)….
    If you look at the spending of an average household (this could be US or anywhere in the world), a large portion of it every month would go in to home rent or in the case of people owning a home interests on mortgages….The policy of reduction in interest rates is supposed to handle that (and as we can already see here in the US the housing prices are dropping though there are not many takers for buying new homes), the next big chunk of spening would go in to commute and food and this is where increase in oil prices play a huge role…and i was told by some of my friends here (i’m not sure how far this is true), the increase in oil prices has also got something to do with the way the profitability model of the oil companies have been setup. So, once the policy makes an impact in bringing down the oil price a good part of the problem should disappear.

    Comment by Aravind — May 12, 2008 @ 4:48 am

  22. I think the author is confusing ‘inflation’ with ‘a general rise in prices’. They are not the same. The former is the cause of the latter.


    Comment by raja r — May 12, 2008 @ 6:17 am

  23. [...] IEB points fighting inflation the wrong [...]

    Pingback by Assorted Links « Mostly Economics — May 12, 2008 @ 9:56 am

  24. I am not sure why you say India belongs to the latter category. You can’t hide when you have inflation. It is there out in the open for people to know what percentage of inflation we currently have. I think the Indian government is doing what it can to curb inflation. The current level of inflation is more of a global problem. Yes, growth of India and China could be one of the main reasons, but it spiraled of primarily because of a crisis in the U.S. real estate market.

    Comment by Avinash — May 12, 2008 @ 10:15 am

  25. Avinash,

    There are several ways of calculating inflation. They take a “basket” of goods and compare their prices with a base year – which may be a fixed year or the previous year. There are ways in which inflation can be manipulated to appear to be less than its acutal value. Often, the office that calculates inflation doesn’t have complete figures of current prices, so they use the previous years prices, if those are not available, they then use the prices of the year before that.
    Therefore, inflation as we know it is infact very low compared to the actual inflation in the Country. I don’t remember the exact numbers, but it’s far higher than what we read in the newspapers.

    Comment by sagarika — May 12, 2008 @ 10:25 pm

  26. Sagarika:

    ‘…so they use the previous years prices, if those are not available, they then use the prices of the year before that.’

    This sounds outrageous. Do you have data to back this claim?

    Comment by photonman — May 12, 2008 @ 11:35 pm

  27. I wonder how adversely affected by inflation is the average reader of this blog? I feel incomes for a section of our society (especially IT and real estate related) have increased lot more in proportion to inflation. And once you exceed a certain income per month, your % expenditure in basics (food and clothing) gets smaller which communication, entertainment, travel, services etc goes up. so even if food doubles in price, it doesn’t really matter. and if one has been smart/lucky to invest in real estate or stocks in last 5 years, going has been great. for some of us, these seem to be wealthiest of times where monthly incomes have grown 20-100 times in the last 10 years.

    note that i’m no economist and this is just an observation of folks around me.

    Comment by ashutosh — May 13, 2008 @ 10:58 am

  28. This prosperity is simply from rupee-dollar arbitration or keeping the value of rupee against dollar much less than what it should be. RBI has been buying dollars to keep the rupee value low and facilitate IT companies, last fiscal the IT industry did about 64 billion business. Now India has about 350+ billion dollar in reserves. The main use of dollar is to buy oil, the oil buying power of dollar has been decreasing steadily form 50 – 127 per barrel in last few years. So you can guess the quantum of lose India is taking to keep IT people prosperous. Top Indian IT companies are listed on US stock exchanges so part of the profit goes back to US elites.

    Comment by Ramesh — May 13, 2008 @ 2:39 pm

  29. Inflation is a serious problem, indeed. But it is NEVER “the world’s number one problem”.

    Criminaliztion of politics, leading to serious deprivation and oppression of the general people may be so, but certainly inflation is not.

    There are several problems that is making our beautiful planet suffer a lot – poverty, violence, illiteracy, violations of human rights, ploitically created social problems like war, riots etc. are far more serious problems.

    Inflation would hardly affect the people in Africa who have no food for months or so.

    Think again!

    Dr. Kushal Banerjee,

    Comment by Dr. Kushal Banerjee — May 13, 2008 @ 9:10 pm

  30. photonman,

    I read this article in Business World. . .

    It’s sometimes weeks, months or years old data that they use.

    Comment by sagarika — May 14, 2008 @ 8:30 pm

  31. To add to Sagarika’s contention on “inaccurate data”, theres one more article in today’s edition of Business Standard.

    As it is WPI (as opposed to CPI) appears to be away from the actual price data on the street. Many readers in this forum have commented on this issue.

    Besides, if the above articles on “inaccurate & unrevised data” are true , then one can only imagine the “real” inflation on the street and the effect its having on the fixed-income earners, daily-wage earners, pensioners & the unemployed.

    Comment by Salty — May 15, 2008 @ 9:22 am

  32. What about the 22 % growth in money supply (M3) as per RBI data year over year ? doesn’t the tremendous increase in M3 result in inflation ?

    Demand constraints are only part of the answer while abnormal rise in money supply is always the major reason for inlfation. and the oil subsisdy still has not been brought into the books of govt (budgets) and when that expoldes in future there will be double digit inflation and hell to pay.

    Govts will never learn to balance their budgets…

    Comment by K.R.Athiyaman — May 15, 2008 @ 10:39 am

  33. Just wait, you haven’t seen nothing yet!
    Where is the effect of the oil company lossess of 550 crores PER DAY (which I am told totals to Rs. 100,000 Crores)? And where is the effect of the Rs. 60,000 crore farm loan waiver? Where is the effect of the Sixth Pay Commission? When all of this kicks in, then we will really have some fun with inflation, you bet!

    Comment by Cool Head — May 16, 2008 @ 10:52 pm

  34. I think one has it’s own perspective of thinking.
    Can we stop him? Excatly yes if we have power to prove it.

    I talk about resolution of Inflation in india.

    Please think on it -

    Privatisation of Indian Ministries will eradicate the root cause of inflation except security and defence.
    Will it ?
    What do you think ?



    Comment by Aditya — May 17, 2008 @ 10:14 pm

  35. government should need to put even more restrictions on export of essential commodities .
    main goal of the indian government should be lowering the rate of steel as rise in steel prices affects economy adversly – rising crude oil prices is another concern for the government

    Comment by himanshu sharma — May 18, 2008 @ 4:50 pm

  36. The first and the best way to curtail inflation is to ban Commodity Trading. The trading of Commodity has unnecessarily given rise to the cost of all the commodity and why not a single analyst has been taking old data of the commodity pricing before and after the start of Commodity Trading.

    The ban on Commodity Exchange of its trading will cut definitely 50 to 80 percent of price rise of the commodity.

    Comment by Nagaraja Gupta — May 29, 2008 @ 8:17 pm

  37. Shiva Moturi,Himansu,Nagraj & others

    The following mail has been forwarded by a friend. It is a testimony by Michael W. Masters, Managing Member / Portfolio Manager of Masters Capital Management, LLC before the Committee on Homeland Security and Governmental Affairs United States Senate May 20, 2008 . It talks about a collective group of investors called ,”Index Speculators” (as opposed to the traditional speculators)in the US commodity markets, whose trading strategies amount to virtual hoarding via the commodities futures markets.

    ———-Start of quote from mail ———————————————-

    Very interesting testimony by Michael W. Masters, Managing Member / Portfolio Manager of Masters Capital Management, LLC before the Committee on Homeland Security and Governmental Affairs United States Senate May 20, 2008. Worth a full read.

    Some excerpt in the testimony:

    A) You have asked the question “Are Institutional Investors contributing to food and energy
    price inflation?” And my unequivocal answer is “YES.”

    B)What we are experiencing is a demand shock coming from a new category of
    participant in the commodities futures markets: Institutional Investors. Specifically,
    these are Corporate and Government Pension Funds, Sovereign Wealth Funds,
    University Endowments and other Institutional Investors. Collectively, these investors
    now account on average for a larger share of outstanding commodities futures contracts
    than any other market participant

    C) These parties, who I call Index Speculators, allocate a portion of their portfolios to
    “investments” in the commodities futures market, and behave very differently from the
    traditional speculators that have always existed in this marketplace. I refer to them as
    “Index” Speculators because of their investing strategy: they distribute their allocation of
    dollars across the 25 key commodities futures according to the popular indices – the
    Standard & Poors – Goldman Sachs Commodity Index and the Dow Jones – AIG
    Commodity Index.

    D)Today, Index Speculators are pouring billions of dollars into the commodities futures
    markets, speculating that commodity prices will increase. Chart One shows Assets
    allocated to commodity index trading strategies have risen from $13 billion at the end of
    2003 to $260 billion as of March 2008,5 and the prices of the 25 commodities that
    compose these indices have risen by an average of 183% in those five years!

    E)In 2004, the total value of futures contracts outstanding for all 25 index
    commodities amounted to only about $180 billion.Compare that with worldwide
    equity markets which totaled $44 trillion, or over 240 times bigger. That year, Index
    Speculators poured $25 billion into these markets, an amount equivalent to 14% of the
    total market.

    F)There is a crucial distinction between Traditional Speculators and Index Speculators:
    Traditional Speculators provide liquidity by both buying and selling futures. Index
    Speculators buy futures and then roll their positions by buying calendar spreads. They
    never sell. Therefore, they consume liquidity and provide zero benefit to the futures

    G)When Congress passed the Commodity Exchange Act in 1936, they did so with the
    understanding that speculators should not be allowed to dominate the commodities
    futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain
    speculators virtually unlimited access to the commodities futures markets.
    The CFTC has granted Wall Street banks an exemption from speculative position limits
    when these banks hedge over-the-counter swaps transactions.21 This has effectively
    opened a loophole for unlimited speculation. When Index Speculators enter into
    commodity index swaps, which 85-90% of them do, they face no speculative position

    H)Institutional Investors are buying up essential items that exist in limited quantities for the sole purpose of reaping speculative profits.

    ———————-end of quote from mail ——————————————–

    Is the phenomenon true for the Indian commodity markets as well ?

    Comment by Salty — May 30, 2008 @ 10:13 am

  38. @ krish
    you say that’gold as currency was the longest running “scam” in the world’. what is wrong in that? what is the pragmatic solution for implementation of the new economic system (i.e food grains as currency)?.
    what are the significant changes it could produce in empowering our economy?.

    Comment by sivanesh — June 11, 2008 @ 12:17 pm

  39. Inflation (Imported or domestic) can only be controlled by monetary policy (RBI) all other measures will fail.

    When you are sick you must take a break from work (reduced Growth)and take bitter medication (Increase in rate to mop cash flow).

    If you do the above you will recover from sickness (Inflation)and be ready soon to work hard (Higher GDP growth)

    You cant maintain high GDP growth while the inflation is high – It is against the fundamentals.

    The hot economy must be cooled down temporarily so we can ride out inflation quickly.

    If the interest rates do not go up during high inflation your currency will fall drastically, this will worsen the inflation as we are a large importer with huge trade deficit.

    This would be followed by economic meltdown (remember 1997 Asian economic crisis – Thailand, Malaysia, Indonesia etc)

    Government and RBI will should apply the breaks and slow down car (economy) while there is danger in the road (Inflation).

    It is not a sin to raise rate and slowdown the growth as Mr Montek sing Aluwalia thinks (planning commissioner).

    What India/RBI has done over the last 3 months is too little and too late.

    I hope by August the RBI brings up the REPPO rate to 9.50% and CRR to 10%.

    This will help the Rupee value and slow the economy, we can have a break and restart the growth process in 6-12 months.

    Indian Petrol price must reflect the global price and then the basic demand and supply logic will reduce the global prices. YOU CANNOT FIDDLE WITH THE NATURE OF ECONMICS. We cannot detach our self in this global village.

    If the goverment is subsidising the petrol price with tax payers money,Then we are paying less for petrol but some school,hospital or road is not being funded.

    Comment by Galicula — July 10, 2008 @ 10:38 am

  40. Inflation is no doubt the biggest economic problem today; at least in few asian countries. the cause as being often repeated by the media and ministers is shortage of goods. going by the theory of demand pull inflation its true. Price mechanism will certainly move the prices upwards in such a situation. the theory so far is proved. but going by the realistic situation I have failed to find to find any scarcity in the amount of daily use and essential commodities. there is no dearth od even expensive commodities like gold and still gold prices are still rising. this finding really confuses me and i feel its here that economic theory and practice differ! does any body have an answer to this?

    Comment by anju singh — July 12, 2008 @ 10:16 am

  41. anju
    Inflation is caused by only one commodity ie crude. Since crude has pass through effect on all aspects of production and consumption all things are up due to cost push inflation. There is no pricing power for any company. They have to simply pass on the cost to consumer. This is classic example of cost push inflation.

    Definitely there is demand push inflation in crude oil. We have seen sporadic shortage of diesel and petrol throughout the world. So we have to pull down demand of oil.

    Comment by satish — July 12, 2008 @ 10:28 am

  42. I agree that governments and central banks are tackling inflation in the wrong way, mainly because the inflation which we are seeing at a global level is not primarily the type of inflation which central banks have the tools to tackle.

    The old addage the “inflation is and will always be a monetary phenomenon” is largely the mantra that central bankers and politicians live by. However a large slice of the recent rise in commodity prices is not due to monetary loosening but due to our inability (at a global level) to increase commodity productivity in line with increasing demand.

    As to the specific question of the price of rice, I would argue that this has less to do with the prevelant rates of interest and more to do with the fact that the way in which rice is brought to market has not advanced significantly this century and the amount of land on which rice is grown has increased dramtically enough to cope with rising population numbers and the increased consumption that comes with economic development.

    Comment by — August 13, 2008 @ 11:00 pm

  43. Indian inflation has another supply side cause apart from global commodity price rise, and that is supply chain speedbreakers. If the supply chain from the farm gate to the store could be made smoother, a lot of the transaction costs would come down. But govt will not allow organised retail FDI as it places the concerns of traders over that of farmers and consumers. India exported about $3 billion of rice in 2007-08, an increase of 87%, and sugar worth $1.4 billion. So global food prices worked for us. The question is what will happen to India’s inflation now that commodity prices are slumping. We may be surpised by continued high inflation, after having blamed global prices for our ills so far.

    Of course, govt expenditure surges do nothing at all to contain inflation.

    Comment by Sharmila — August 18, 2008 @ 10:15 am

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