By Simon Grey, on January 24th, 2012
In many ways the monetary policy issue is even more important, simply because we are running out of rope on our national debt-addiction rappelling adventure and the floor is still 100′ down. That’s a serious problem — and “gold standards” do not (in fact cannot!) fix it. The only fix that works is to demand and enforce a zero-CPI standard with honest statistics, along with an end to federal government borrowing — period. “Hard money” .vs. “Fiat money” is immaterial; if you permit fraud in the monetary and credit system, as we have, the rest simply does not matter and yet if you put a cork in the frauds and lock up the scammers then you quickly come to the conclusion that allowing a handful of producers of some metal, the majority of which are foreign entities, is the last group you want running your monetary policy!
The Paulites get this wrong and so does Ron Paul himself despite the historical fact that the United States had massive inflationary bubbles and detonations of them during the time it was on the Gold Standard. 1873 anyone (as just one example.)
The real problem in 1873 as with all other similar blowups was the issuance of bogus debt instruments unbacked by anything. In the case of 1873 concentration was in railroads and related construction all financed by long-duration bonds (and therefore subject to high degrees of price risk due to their duration) but which were entirely-speculative and in fact for which there was no actual demand in the economy for the services (transportation to be provided by said railroads) at a level sufficient to meet the intended expense. It didn’t help that we were playing games with our exports (and Europe with its imports) much as China and the US are today, effectively hiding the bubble’s impact for a period of time and allowing it to inflate to ridiculous size. When the over-leveraged positions became exposed the game collapsed and the Long Depression followed. [Emphasis original.]
Denninger correctly notes that a gold standard, in and of itself, is not enough to prevent a bubble of any sort. He also correctly notes that enforcing a zero-CPI standard would fix the current currency mess. However, what he seems to neglect in his analysis is that the real problem is not with the proposed solutions, but the fact that the government has to enact and enforce them.
This then begs the obvious question: given the government’s obvious failures to prevent bubbles by keeping money honest, regardless of the money is metal or digital, why then even bother to put the government in charge of the money supply? They can’t manage it properly when gold is money, and they certainly can’t manage it properly when paper is used as money. Why then trust them with it?
The better solution is to simply allow currencies to freely compete with each other, which will have a strong tendency to ensure that currencies remain sound, strong, and free from inflation. By the way, there is one presidential candidate who has proposed legislation that would do exactly this. We all know who he is.
By Ajay Shah, on November 7th, 2011
On 25 October, Dr. Subbarao announced a 25 basis point hike in the policy rate. Alongside this, he made statements that were widely interpreted as being dovish:
Keeping in view the domestic demand-supply balance, the global trends in commodity prices and the likely demand scenario, the baseline projection for WPI inflation for March 2012 is kept unchanged at 7 per cent. Elevated inflationary pressures are expected to ease from December 2011, though uncertainties about sudden adverse developments remain.
…
Inflation is broad-based and above the comfort level of the Reserve Bank. Further, these levels are expected to persist for two more months. … However, reassuringly, momentum indicators, particularly the de-seasonalised quarter-on-quarter headline and core inflation measures indicate moderation, consistent with the projection that inflation will begin to decline beginning December 2011.
…
The projected inflation trajectory indicates that the inflation rate will begin falling in December 2011 (January 2012 release) and then continue down a steady path to 7 per cent by March 2012. It is expected to moderate further in the first half of 2012-13. This reflects a combination of commodity price movements and the cumulative impact of monetary tightening. Further, moderating inflation rates are likely to impact expectations favourably. These expected outcomes provide some room for monetary policy to address growth risks in the short run. With this in mind, notwithstanding current rates of inflation persisting till November (December release), the likelihood of a rate action in the December mid-quarter review is relatively low. Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted.
WPI inflation is not interesting in thinking about monetary policy. The WPI basket is not consumed by any household. The right measure of inflation that all of us should focus on is the CPI.
We just released an updated batch of seasonally adjusted data, and the news for inflation, for September 2011, is bad. CPI-IW grew at an annualised (seasonally adjusted) rate of 20.15% in September 2011. As a consequence, the 3-month moving average inflation went up from 8% in August to 11.77% in September. If we compute the policy rate as the halfway mark (8%) and subtract out this latest value of the 3-month moving average inflation rate (11.77%), the policy rate expressed in real terms is -377 basis points.
Here’s the picture of what’s been going on with point-on-point seasonally adjusted CPI-IW inflation:
The key fact about India’s inflation crisis is: “Headline inflation”, which I would define as the year-on-year rise of CPI-IW, has been outside the target range of 4-5 percent in every single month from February 2006 onwards. High inflationary expectations have now set in. Given what is happening on prices of both tradeables and non-tradeables, I find myself skeptical about the sanguine picture on inflation that was painted on 25 October.
The bottom line: Headline inflation (year-on-year rise of CPI-IW) went up from 8.99% in August to 10.06% in September. This is inconsistent with a sanguine analysis of inflation on 25 October.
Or perhaps the econometricians at RBI have some aces up their sleeves. Will point-on-point seasonally adjusted inflation, under the benign influence of a strongly negative real rate, veer back into the 4-5 per cent range by December 2011? Stay tuned. So far, the score is: September 2011, 20.15%.  
By Ajay Shah, on October 25th, 2011
A few days ago, I wrote a blog post about India’s inflation crisis. For five years now, in every single month, the y-o-y CPI inflation has exceeded 5%. Under these conditions, economic agents have little confidence that RBI cares about inflation. They are now reporting double digit inflationary expectations. Under these conditions, inflation will be persistent. By itself, inflation is not going to go back to the target range of 4 to 5 per cent. This blog post made certain qualitative claims about fighting inflation under two scenarios: when the central bank has credibility and when it does not.
I recently came across a fascinating paper which is about a similar situation: it is about the problems faced in Ghana recently, in fighting back an inflation. It gives numerical values which are interesting for us. Their inflation was a bit worse than ours – they were at 20%. But for the rest, this analysis illuminates what we face in India today. The paper is : A model for full-fledged inflation targeting and application to Ghana, by Ali Alichi, Kevin Clinton, Jihad Dagher, Ondra Kamenik, Douglas Laxton and Marshall Mills, IMF Working Paper, 2010.
Here is the main story. First, look at the projected trajectory for what happens to the short term interest rate and inflation under conditions of weak credibility of the central bank:
The nominal rate is required to go all the way out to 26%. Inflation responds slowly. It is projected to get to the target (with some overshooting at first) by 2016. The cumulative damage to GDP growth, in this process of exorcising inflation, works out to roughly 20 per cent of GDP. (This is the sum total of the output cost over all the years taken in wrestling this inflation down).
Compare this against the picture obtained when the central bank has high credibility:
This is much nicer story. The nominal interest rate starts out high (18%) but inflation responds rapidly and the interest rate can also come down rapidly. By 2013, inflation is at the target. The cumulative damage to GDP growth, in this process of exorcising inflation, works out to only 4% of GDP.
This difference is striking. Lacking credibility, the central bank has to force a total output loss of 20% of GDP, and they get to target inflation by 2016. With credibility, the job gets done three years sooner, and at a cost of only 4% of GDP of output loss.
This is an essential insight into our inflation crisis today. In the end, raising rates will get the job done. No matter how bad is the monetary policy transmission, no matter how deeply ingrained inflationary expectations have become, raising rates will ultimately deliver price control. The choice that we face is between being bloody-minded about it, or simultaneously undertaking RBI reforms which involve zero output loss, and improve RBI’s credibility.  
By Ajay Shah, on October 18th, 2011
A lot is being written about inflation in India today. I thought it’s worth writing about the fascinating insights into inflation that come from focusing on the distinction between tradeables and non-tradeables.
What is a tradeable
A tradeable is a product which can be transported across the world at relatively low cost. As an example, steel is tradeable while cement or paint are mostly non-tradeable barring special short-hop opportunities like Gujarat-Karachi or Amritsar-Lahore or Calcutta-Chittagong or Trivandrum-Colombo.
Steel is a nice tradeable that one can think clearly about. There are no barriers to the movement of steel worldwide. Hence, there is only a world price of steel. The quoting convention used worldwide is to express the price of steel in USD. The price of steel in India is thus the world price of steel multiplied by the INR/USD exchange rate, plus a markup for freight (The cif/fob ratio).
If there is a customs duty of (say) 10%, then the price of steel in India is 1.1 times the world price of steel expressed in rupees. For the rest, nothing changes when a customs duty is introduced. Gram for gram, every fluctuation in the INR/USD or the world price of steel shows up in the domestic price of steel.
Non-tradeables are things like cement (which are hard to transport) or haircuts (which are impossible to transport).
Measurement
Before we can analyse and control inflation, we must measure it well. Inflation is defined as the rise in the price of the average household consumption basket. The CPI is the best measure of inflation in India.
Everything in the CPI basket can be classified into the two categories: tradeable vs. non-tradeable. As a thumb rule, WPI non-food non-fuel is a rough measure of tradeables inflation. Fluctuations in food and services prices, which make the CPI diverge away from WPI non-food non-fuel, are a measure of non-tradeables.
Year-on-year inflation reflects an averaging over 12 months. If you want to get a faster sense of what is going on, you need to look at point-on-point seasonally adjusted changes. These yield early warnings of inflation, which are 5.5 months ahead on average. Such data is updated every Monday by us. The shift from y-o-y inflation, to p-o-p SA inflation, is a free lunch in measurement and monitoring.
The WPI is a useful database of many price time-series in India. But the overall WPI is useless in thinking about inflation in India: there is no household in India which consumes the WPI basket.
The use of WPI inflation, and the exclusive use of y-o-y inflation, are litmus tests of professional competence in the Indian landscape.
The function of the central bank
The job of RBI is to deliver low and stable inflation: to deliver y-o-y CPI inflation of between 4 to 5 per cent.
They have failed in this task. From February 2006 onwards, in every single month, y-o-y CPI inflation has exceeded 5 per cent. This is an important time for introspection at RBI and outside it. What have we done wrong, in the structuring of RBI, which has got us into this mess?
It is useful to think of this as a principal-agent problem. The people of India are the principal. RBI is the agent. The principal hires the agent and gives him resources. In return, the agent has to be held accountable. Delivering low and stable inflation is the accountability mechanism. It is a quantitative monitorable measure of the performance of the central bank. That we have sustained failure on this function, from February 2006 onwards, suggests that we should be modifying the nature of the contract between the principal (the people of India) and the agent (RBI).
How RBI can influence the price of tradeables
RBI has absolutely no say on the world price of steel. In that sense, the prices of tradeables are beyond the control of RBI.
When RBI raises the interest rate, more capital comes into India, which tends to give an INR appreciation, thus making tradeables cheaper. Thus, an RBI rate hike does impact upon the domestic price of tradeables.
It is also worth pointing out that the central banks of most major countries are high quality inflation targeters. They deliver on their mandate of delivering low and stable inflation. As a consequence, inflation in the global tradeables basket tends to be low and stable. Tradeables prices are a helpful source of price stability, most of the time.
(That a large part of the CPI basket is tradeable, and seemingly beyond the control of the central bank, is no excuse. There are dozens of high quality central banks visible in the world, with very large shares of the CPI basket in tradeables, who are delivering on inflation targets. We in India should not accept excuses).
How RBI can influence the price of non-tradeables
Non-tradeables reflect aggregate demand and aggregate supply in India. RBI can influence these by raising or lowering the short-term interest rate. When interest rates are made slightly higher, household consumption and investment demand are slightly lowered.
A critical feature of non-tradeables inflation is expectations. If people expect 10% inflation, they tend to wire high price rises into their negotiation of wage and other contracts. This generates inflationary momentum. Particularly in a place like India, where the institutional structure of monetary policy is primitive, economic agents have little confidence in the ability of policy makers to rein in inflation. As a consequence, inflation is highly persistent. Once high inflation sets in, economic agents expect high inflation to continue. There is a great deal of momentum in inflation.
For years now, some economists have argued that inflation will subside by itself. It will not. Inflation does not mean-revert to the target zone of 4 to 5 per cent by itself. We are now in a trap of high inflationary expectations. This structure of expectations will need to be broken. This can happen in two ways. RBI needs to turn a new coat, and convince people that it now cares about inflation without any other conflicts of interest. And, rate hikes have to take place.
There are two paths to inflation control: changing the structure of expectations and reducing aggregate demand. The former is almost a free lunch. It only requires institutional change. The latter is hard work; it inflicts pain.
What about supply factors?
Some argue that supply bottlenecks in India – such as hideous rules about mandis – are the cause of inflation.
The trouble with this explanation is that the supply bottlenecks have always existed. They have existed in high inflation times and in low inflation times. It is, thus, not possible to claim that supply bottlenecks have caused the inflation crisis which began in February 2006.
Can rate hikes deliver inflation control?
When C. Rangarajan was RBI governor, there was an inflation crisis, and rate hikes did deliver on inflation control. The phase of price stability ushered in then lasted all the way till February 2006. This shows us that even in India, it can be done.
We have to remember that in his time, the monetary policy transmission was much weaker than what we see today. With a bigger wall of capital controls, domestic rate hikes did not deliver inflation control by impacting on the INR (through higher capital inflows). With a smaller and weaker Bond-Currency-Derivatives Nexus, the monetary policy transmission from the short rate into aggregate demand was inferior, then. Yet, he got it done.
Conversely, with a very primitive financial system and monetary policy transmission, the central bank of Zimbabwe delivered a nice hyperinflation. We can quibble about the potency of the monetary policy transmission, but we should not doubt the ultimate domination of monetary policy in shaping inflation. In the long run, little else matters in shaping inflation.
Part of the story of the 1990s lies in clarity of purpose at RBI and policy credibility. Rangarajan’s period had good quality speeches, which did not dilute the message on inflation control as the dharma of the central bank. In contrast, in recent times, RBI has repeatedly written low quality speeches. To an expert reader, they have conveyed the lack of knowledge on monetary economics at RBI. To the non-expert reader, they have waffled on the subject of taking responsibility, and have encouraged the average economic agent to think that high inflation is here to stay.  
By Ajay Shah, on April 29th, 2011
Inflation measurement is a critical component of macroeconomic policy. In a recent paper, Patnaik et. al. have argued that while the CPI-IW has many problems, these difficulties are not first order, and that the CPI-IW can yield a reasonable measure of inflation today.
On 18 February 2011, CSO released a new CPI with base year 2010 (Jan-Dec =100). This new CPI has five important new features:
- It is disaggregated at the rural and urban levels. The new overall all India CPI is a weighted average of the two. This is in contrast with the earlier CPIs which represented subsets of the population (industrial workers, agricultural labourers, rural
labourers, etc.).
- The new series has better geographical as well as commodity coverage. The basket of consumer goods has risen from 25 to 250. The weights have been derived from the 61st round of the NSS consumer expenditure survey (2004-05).
- Data for the urban CPI will be collected from 310 towns (compared to 78 in the current CPI-IW, for all India). The rural CPI will use data from 1181 villages. Field officers of the NSSO and the Department of Post will be the price collection agents for urban and rural centers respectively.
- Since the two series are not comparable, year-on-year inflation numbers based on the new CPI will be available only from February 2012.
| Sub Group |
|
New CPI |
|
|
|
Rural |
Urban |
All India |
CPI IW |
| Food, beverages and tobacco |
59.31 |
37.15 |
49.71 |
50.20 |
| Fuel and Light |
10.42 |
8.40 |
9.49 |
6.25 |
| Clothing, bedding and footwear |
5.36 |
3.91 |
4.73 |
13.28 |
| Housing |
0.00 |
22.53 |
9.77 |
5.33 |
| Miscellaneous |
24.91 |
28.00 |
26.31 |
24.94 |
The share of food in the new CPI series has seen a small dip in comparison to the CPI-IW while the share of services has risen. The
share of housing has also seen a sharp rise. In CPI-IW, the price of housing services was imputed from the house rent allowance given to civil servants. For the new CPI series, housing prices will be collected through surveys of a sample of rented dwellings in 310
towns.
The weights in the new CPI are taken from a household survey by NSSO. This is, however, already quite dated given that it was
conducted in 2004-05. It is hence interesting to compare these weights with those seen in the CMIE Consumer Pyramids dataset, which goes upto the quarter ending Dec 2010. This is a panel dataset where 140,000 households are measured every quarter.
The household basket as shown by CMIE gives a weight to rent based on households that report rent. The CPI uses an imputed rent. An imputed rent calculation for the CMIE data is not feasible based on the information presently given out by CMIE. In order to render the two comparable, we purge both consumption baskets of rent.
| Sub Group |
New CPI, rural |
CMIE: Oct-Dec 2010, rural |
| Date |
2004-05 |
2010-11 |
| Food, beverages and tobacco |
59.31 |
59.57 |
| Fuel and Light |
10.42 |
12.12 |
| Clothing, bedding and footwear |
5.36 |
3.75 |
| Miscellaneous |
24.91 |
24.54 |
In rural India, the weights of food and miscellaneous in the new CPI match that seen in the CMIE consumer pyramids even though the CMIE dataset is much more timely. In comparison to the Consumer Pyramids weights, fuel and light is under-weighted while the clothing category is over-weighted in the new CPI. The fact that these differences are small gives us increased confidence in the NSSO and in the new CPI.
| Sub Group |
New CPI, urban |
CMIE: Oct-Dec 2010, urban |
| survey in |
2004-05 |
2010-11 |
| Food, beverages and tobacco |
47.96 |
45.95 |
| Fuel and Light |
10.84 |
16.45 |
| Clothing, bedding and footwear |
5.04 |
3.78 |
| Miscellaneous |
36.14 |
33.82 |
A similar comparison in urban India shows noticeable differences in all categories. The weights for the food group is lower in the CMIE data. Both the clothing and the miscellaneous categories exhibit similar patterns. The fuel group has a significantly higher weight in Consumer Pyramids. Over time, the role of fuel has risen.
| Sub Group |
New CPI, all India |
CMIE: Oct-Dec 2010, all India |
| survey in |
2004-05 |
2010-11 |
| Food, beverages and tobacco |
55.09 |
53.48 |
| Fuel and Light |
10.52 |
14.06 |
| Clothing, bedding and footwear |
5.24 |
3.77 |
| Miscellaneous |
29.16 |
28.69 |
All India weights reveal similar patterns as urban India weights. This is not surprising because all India figures are weighted
averages of rural and urban weights.
Assuming NSSO did a good job of measurement in 2004-05, this suggests that over a short period of time, the expenditure pattern
of Indian households has been changing at a fast pace.
Despite the issue of weights, the new CPI series is a welcome step. Improvements in inflation measurement will be an important
component of the Indian process of refashioning monetary policy to deliver low and stable inflation.
By Ajay Shah, on February 8th, 2011
Ila Patnaik, Giovanni Veronese and I have a paper titled How to Measure Inflation in India?. The abstract reads:
What is the best inflation measure in India? What inflation measure
is most relevant for monetary policy making in India? Questions of
timeliness, weights in the price index, accuracy of food price
measurement, and inclusion of services prices are relevant to the
choice of measure. We show that under present conditions of
measurement, the Consumer Price Index for Industrial Workers
(CPI-IW) is preferable to either the Wholesale Price Index or the
GDP deflator.
Inflation measurement in India may just get significantly better, with the release of the new CPI. The paper should help in evaluating this new CPI and in evaluating its applications.
By B.P.T., on April 14th, 2010
The Mortgage Bankers’ purchase index was released at 7:00 AM EDT, and there was a week to week decrease of 10.5% last week, due to an increase in FHA mortgage premiums and causing concern about the housing market as the second federal stimulus program comes to an end.
At 8:30 AM EDT, the Consumer Price Index report for March will be released. The consensus is that CPI will be up 0.1% for last month, with a 0.1% increase in CPI when food and energy are removed.
Also at 8:30 AM EDT, the Retail Sales report for March will be released. The consensus is that retail sales increased 1.2% from February because of poor weather in February, strong auto sales, and an early Easter.
At 10:00 AM EDT, the Business Inventories report for February will be released. The consensus is that inventories increased 0.5% from January, after no change in the previous month.
Also at 10:00 AM EDT, Federal Reserve Chairman Ben Bernanke will testify to the Joint Economic Committee about the economic outlook in Washington.
At 10:30 AM EDT, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update on oil inventories as oil prices continue to move higher.
At 2:00 PM EDT, the Federal Reserve will release its next Beige Book report, providing reports on economic conditions in each of the 12 Federal Reserve districts.
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By Ajay Shah, on May 22nd, 2009
riting in Business Standard today, Surjit Bhalla has a table of the vote share of the CPI and the CPI(M) put together. I thought it would be useful to see this data as a time-series, so here is the result.
Click on the graph to see it more clearly. Each circle is a data point. The dashed line is a (robust) regression with a shift in the intercept in 1991, reflecting the fall of communism. As we can see, the fall of communism seems to have gone along with a loss of vote share of 1.3 percentage points for the Left.
The latest result is a bit worse than the trend line might have suggested: tactical factors went a bit against the Left. At the same time, the CPI and CPI(M) leadership can take heart: the latest result is not all that far from the historic decline of the left, so this does not suggest that the leadership made particularly large tactical errors. What they are perhaps up against is historical forces.
The red coloured plus sign is the linear extrapolation for 2014; the slope implies losing roughly 0.13 percentage points of vote share each five years. (The statistical signifiance is weak; it’s a t stat of -1.52).
Here’s the R code which you can experiment with:
library(MASS)
dates <- c(57,62,67,71,77,80,84,89,91,96,98,99,104,109)+1900
vshare <- c(8.9,9.9,9.4,9.8,7.1,8.7,8.6,9.1,8.7,8.1,6.9,6.9,7.1,6.8)
post1991 <- dates > 1991
m <- rlm(vshare ~ -1 + dates + post1991)
summary(m)
m$coefficients[1]*5 # lose this much each gen. election
png(”ic.png”, width=550,height=550, pointsize=16)
par(mai=c(.8,1.1,.2,.2))
plot(dates, vshare, type=”p”, xlim=c(1957,2014), xlab=”", ylab=”Vote share of CPI + CPI(M)”)
lines(dates[1:9], fitted.values(m)[1:9], lty=2, lwd=2)
lines(dates[10:14], fitted.values(m)[10:14], lty=2, lwd=2)
abline(v=1991, col=”red”, lwd=2)
points(2014, m$coefficients %*% c(2014,0,1), cex=3, col=”red”, pch=3)
text(1966,9.1,”Regression line pre-1991″,cex=.7)
text(2003,7.3,”Regression line post-1991″, cex=.7)
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