Deciphering and solving the inflation crisis

India has an inflation crisis. From 2006 onwards, the Y0Y rise in CPI-IW seems to have gone unhinged:

Why did this happen? We have a `Nobody killed Jessica’ situation here. Sharad Pawar and D. Subbarao both insist that the problem cannot be laid on their doorstep. I would argue that it was the currency policy from 2003 onwards (large purchase of dollars with partial sterilisation) which gave us this mess, which was then compounded by repeated RBI speeches saying that inflation is not important, and RBI actions which were soft on inflation.

The weakness of macroeconomic thinking in official circles is visible, with government actions including banning exports, sending the police to raid traders and hoarders, etc. I believe there is an iron law of economic policy: across each doubling of GDP, you have to reinvent government. The trouble in India is that we are getting each doubling of GDP in a decade or less, giving a very large gap between the structures of government and the underlying conceptual frameworks, when compared with the requirements of the economy. With agriculture at only 15% of GDP, one has to think differently about the role of food in inflation as a macroeconomic phenomenon. Getting back to stable 4% inflation is terribly important, and it’s going to be hard. In recent weeks, Ila Patnaik has written four newspaper pieces which add up to an interesting perspective on inflation: 20 Dec, 25 Dec, 3 Jan, 13 Jan. And, a blog post of mine on food price volatility may also be useful.

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