How to tackle inflation

Ajay Shah / New Delhi February 07, 2007


One of the great strengths of India is that the political system just does not accept high inflation.

Is the government getting needlessly hysterical about inflation? Many people think it is okay to tolerate some inflation if, in return, it is possible to sustain higher growth rates. Nothing matters as much for peace, prosperity and poverty alleviation as high GDP growth, so I would always advocate any policy which delivers higher sustained GDP growth. However, the link between inflation and growth is complex. High inflation does not give high growth. The growth miracles of Asia, where above 7% growth was sustained over a 25-year period, were not associated with high inflation. In fact, countries with high inflation have tended to have low growth.

In the business cycle, an acceleration of inflation can support a temporary acceleration of growth. In India, expected inflation has gone up from roughly 3% in 2004 to roughly 7% today--a rise of 4 percentage points. Interest rates have risen by less than 4 percentage points. As a consequence, real interest rates have actually gone down. Borrowing has become cheaper; we have a credit boom; and this is giving heightened GDP growth.

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