Can monetary policy alone control inflation in the economy?

Inflation is a much debated subject in India in recent times and is the apparent cancer of Indian Economic Growth. RBI’s Monetary Policy is seen as a panacea, by the State and the laymen, for arresting this cancer’s mushrooming growth in the financial sector. But, this is a wrong approach as RBI also has its limitations. The State cannot delegate the duty of maintaining the financial health of the country in the tied-down hands of RBI. RBI has its hands tied-down because monetary policy plays a limited role. In contrast, Fiscal Policy plays a huge role in this financial equation. The absence of harmony between the objectives and aims of the monetary and financial policies also seems apparent.

Supply Side Inflation: There is a need therefore for looking more into the supply-side responses. Monetary and Fiscal Policies should not only concentrate on demand push inflation, but also on cost push inflation. In Indian realm, unfortunately, Inflation is misunderstood as just as Demand push inflation only.

Structural Reforms: There is need for structural reforms to take place on the fiscal front. The food inflation occurs especially due the systemic flaws (for e.g. large dependency of Indian Agriculture on Monsoon, lack of agricultural infrastructure etc.). There is need for work at this end.

Import Inflation: There is a need for dealing with the issues of Import Inflation. The dependence on imported goods for which highly valued foreign currency has to be paid also has been underplayed time and again.

Inflation Indexing: Need for a core inflation sector index to be adopted by the RBI, as one of the parameter, for deciding its monetary policy which excludes those sectors over which RBI’s policies don’t have much control. E.g. In USA, a core inflation index excludes food and oil from the basket because prices of these commodities do not respond to Federal Reserve policy. The excluded items differ from country to country depending on their volatility. This will make RBI’s aims more realistic.

From above discussions one can infer that a simplistic inflation-targeting approach i.e. Fighting inflation first through stabilization and worrying about growth later is an IMF approach that has not worked well elsewhere in the world and will not work in India. We need a more comprehensive approach that will revive growth and lower inflation simultaneously. The interactions between monetary, fiscal and supply-side policies will need to be taken into consideration to get out of our current stagflationary predicament.