Can the Reserve Bank of India rein in food inflation?

“Growth is not robust in the sense that it is generating employment or there are better wage conditions or [high] domestic consumption. The argument that growth is robust shows a deep lack of understanding of the phenomenon of asset bubbles and how it affects aggregate gross domestic product,” Jayati Ghosh, economist and professor at the University of Massachusetts Amherst, said.

The reasons behind runaway food inflation are issues such as climate change, higher prices for agricultural inputs and declining agricultural yields, according to Ghosh, who stressed that monetary policy isn’t the right tool to fight food inflation. “The critical point is inflation concentrated in food; it is not widespread. And even with food, inflation is not led by demand because we know that aggregate consumption is down,” Ghosh said. “This is cost-push inflation. And the relevant tool to fight it is not interest rates.”

“Food inflation is not necessarily driven by demand factors but significantly more by supply factors. Whether monetary policy itself can have an impact on the supply side and the agricultural sector is not clear. If food inflation is judged to be more persistent, then it would lead to higher rates for longer so as to constrain demand elsewhere in the economy,” Zook said.

Ghosh said that food inflation is not driven by demand, and in such a scenario the central bank cannot use monetary policy to bring inflation down. On the other hand, food inflation should be tackled by the government using fiscal policy, by increasing investments in agricultural supply chains, for instance. “It is not a question of inflation versus growth — and it happens only if you believe in Philip's curve situation, which doesn't apply to developing economies,” she said.

The Phillip’s curve is a historical inverse relationship between inflation and unemployment, meaning if more people have jobs, there will be more money in the economy and hence high inflation. “If you seek to control inflation via monetary policy, you probably can but at a huge cost to the real economy - inflation will come down with high interest rates but so will people's real incomes,” Ghosh said. “You are likely to weaken economic activity further.”

“What worries me in general is that the government has not understood the nature of the current inflationary period. In the same way that it has not understood the nature of the current employment crisis,” Ghosh said.

Ghosh called on the RBI to correctly identify the reasons behind the rise in food prices. “Is it oligopolistic behaviour? Is it supply chain issues? is it the devaluation of the currency? Check out all these factors, assess the relative importance and see which of these you can use policy instruments on,” she said.