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LATEST NEWS UPDATES | How Well Does India Understand Inflation? -Deepanshu Mohan

How Well Does India Understand Inflation? -Deepanshu Mohan

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published Published on Jul 27, 2016   modified Modified on Jul 27, 2016
-TheWire.in

Policy makers should conduct deeper analysis on the many subtle factors that shape inflation and its effects on the Indian economy.

In 1923 when Rudolf von Havenstein, the president of the German Reichsbank (later known as the Deutsche Bundesbank), recklessly initiated a money printing drive in response to the German government’s demand to spend more money, Germany was inevitably embroiled in a bout of hyperinflation and its worst crisis of the 20th century. Havenstein issued new money equal to two-thirds of the money in circulation then and it took almost two decades for Germany to fully recover from its worst economic disaster. Over time most developed economies, including the US after the 1970s, along with emerging markets realised that inflation is an immensely important economic variable that influences the mood of the electorate with virtually no time lag.

At the risk of oversimplification, inflation quite simply occurs when in the short run, too much purchasing power is chasing too few goods and services. In a simple demand-supply relational model, an increase in demand or an insufficient supply can cause a higher rate of inflation (in food, fuel etc.). However, such a simple demand-supply relational model for goods and services cannot entirely explain inflation, especially for emerging economies. In some egregious cases we can put it down to reckless money creation by the central bank (as in the case of Germany during 1920s) or overspending by government (as in the case of India under Indira Gandhi during mid-1970s). There are some more subtle sources for causing inflation that may have to do with the changing banking behaviour on the part of individuals (let’s say parking more of their household savings in banks), or the availability of new mediums of exchange, also called cryptocurrencies.

In India’s own recent context, one of the major achievements during Raghuram Rajan’s time as RBI governor in the last three-four years has been demonstrated by his ability to keep the average prices of most consumer goods low, thus maintaining a manageable rate of inflation. Rajan may have been pilloried by his critics for keeping short-term interest rates high in claiming to restrict India’s growth (cap)abilities, but the overall retail inflation (based on the computation by Consumer Price Index) is largely below 6% (5.77% to be precise) which is a very manageable rate of inflation for an emerging economy like India.

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TheWire.in, 25 July, 2016, http://thewire.in/53660/how-well-does-india-understand-inflation/


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