Why the Theory of Inflation Needs To Be Relooked into
Dr TV Gopalakrishnan 28 April 2022
"Many of the economic challenges we face today stem from the neglect of supply side policies over the past decade or more." Augustine Carstens (Times of India). 
 
At 14.55%, March Inflation Hits Four Months (High Business Line)
 
Price Rise, Geopolitical Woes Offset Gains After Third Wave Ended (Reserve Bank of India -RBI) 
 
Is it not time for the policy-makers to think of some practical measures through improved administrative means to contain inflation? While inflation generally affects all, the fact remains that the poorest of the poor gets affected the worst, the lower middle class suffer very badly and the middle class also gets hit to a great extent. The only class perhaps untouched by inflation is the rich and the inflationary conditions enable them to become richer and enhance their wealth eventually. Money begets money. 
 
Inflation also impacts family bonds as the masses having hand-to-mouth existence are also subjected to emotional, physical, financial, psychological and social pressures that the practitioners of monetary theory for containing inflation seem to miss out very badly. 
 
The theory of 'too much money chasing too few goods' does not appear to be entirely relevant these days because while inflation is induced by war or geo-political tensions, interest rates, the flow of international trade, or funds seeking better avenues of investment or is imported, thanks to the dynamics of exchange rates, the majority of the population remains poor and does not make any money, so to say.
 
Similarly,  domestic inflation due to unexpected spread of the pandemic disturbing all-round growth of goods and services, faulty distribution of money caused by inequitable tax policies resulting in a few people accumulating wealth, lack of accountability and administration in the supply-chain bottlenecks: all these factors cause inflation of a different kind where the shortage of money keeps people away from demanding even the essential goods for survival. 
 
Demand-driven inflation is understandable, provided the majority of the population enjoys reasonably good income, employment is high, production and storage, transportation, and marketing and distribution of essential goods among the people are carried on smoothly by providing cheap credit and other logistics. 
 
Multiple factors cause inflation. The concept of maximum retail price (MRP) without relevance to the cost and the margin of profit, the applicability of goods and service tax (GST) to mass consumption goods without adequate justification of their affordability, non-inclusion of fuel under GST are the policy-related causes. Besides, all sorts of malpractices at ground level starting from greedy pricing without any check, hoarding, black marketing and operations of money lenders abetting all rules and regulations, and corrupt practices, add to the supply-chain bottlenecks resulting in high cost of the products. Man-made inflation is higher than money made inflation. 
 
Unfortunately and ironically, the irresponsible behaviour of media and of the not so enlightened public, get fully exploited by the market men by jacking up prices, a feature perhaps unique to our economy. Being an abnormal situation, this sort of inflation needs an unconventional solution.   
 
The honest and the people who care for ethics and values silently suffer the worst from inflation and its related consequences. 
 
The scenario of suffering due to high and uncontrolled inflation is more visible and pathetic in poorer countries as the affordability of the rich and the poor to withstand the cruel face of inflation varies drastically. It also helps the rich remain unruffled and allow the poor to succumb to poverty-driven pressures without being even noticed, unfortunately. 
 
The poorest of the poor, whose ambitions and aspirations are very limited, cannot be expected to appreciate the difference between imported and domestic inflation. Even a one rupee increase in his expenditure without a matching rise in his income affects him financially, emotionally and psychologically . Unfortunately, it does not seem to be appreciated or understood by the powers that are managing money and people. All are born equal, but many get social and economic status based on artificial rules and regulations and the majority live on hopes and expectations of the elusive 'Achhe Din'.          
 
A huge segment of the population has no money to buy two square meals a day.  Shortage of cash with the many and surplus of cash with the few causes imbalances in society so that frustration, desperation and depression multiply among the people, leading to loss of productivity and so goes the vicious circle. 
 
People do not have money and the gap between the haves and have-nots has been widening without anybody being particularly worried, although freebies rescue some at a very high cost and value to the society. 
 
Corruption plays havoc, and those who make money by all possible means do not suffer from inflation. This segment of the population is on the increase, adding to demand induced inflation.  and miseries and worries to many as to how to survive, without any hope. Welfare living is almost forgotten. 
 
The need of the hour is to reduce taxes for the poor for all their essential consumer goods, enhance administrative skills to contain all sorts of malpractices seen at various stages of production, storage, transportation, marketing, including disposal of wastes,  reduce corruption, enhance accountability, reduce black money and enhance tax collections through attractive and incentivised tax compliance. Also, we need to pursue soft policies that encourage the smooth flow of supply of all essential goods and services. Public transportation systems like railways can definitely make the movement of essential goods faster, safer and cheaper. 
 
The time has come to seriously think of something more than traditional rhetoric and initiate concrete measures in the equitable distribution of income rather than an equitable levy of taxes from those who earn and those who do not earn. On the one hand, we see individuals earning Rs2.5 lakh a year, with a family to support while on the other are persons earning in lakhs and crores with multiple avenues to multiply incomes with or without taxes. The gap between the two needs to be recognised, realised, and factored in while making policies and implementing measures to contain inflation.
 
There is a paramount need to have a comprehensive taxation policy benefiting the people, the government and the economy by bringing under the tax net all segments of the population and sectors. 
 
While GST seems to be a wonderful option, excluding items like fuel from GST needs to be reviewed and changes brought in early to rationalise tax rates and simplify tax collections for enhanced compliance. There seems to be no relationship between the outflow of money towards taxes from a poor man's income and the outflow of money from a rich man's income towards taxes. The money left with the poor for procuring essential consumption goods needs to be considered while rationalising the taxes under GST, direct taxes and other levies.   
 
At ground level, the majority of the masses do not differentiate between fiscal and monetary policy or imported inflation and domestic inflation. Their only aspiration is to survive, coexist with others and enjoy a peaceful, happy, contented and safe life. By force or by design, they lead a simple life and add values and ethics to society. 
 
The majority, perforce, practises simple living and high thinking preached by the high and mighty Inflation should not spoil very simple aspirations of the majority of the people and they should not become poorer and poorer because of adverse effects of inflation. 
 
Money is what money does. However, it cannot, and should not, be the cause of suffering for many. Inflation caused by money and its mishandling by a few, ignoring the welfare of many, needs to be tackled through very strong governance system, sustainable, highly need based and result oriented fiscal and monetary measures in tune with the aspirations of the majority of the people. 
 
Interest in life has a direct link with the real rate of interest and the need to protect real interest rate from high inflation rate is paramount. The health of the economy and the health and wealth of the people cannot be exposed to the dangers of any form of inflation for want of an effective and meaningful governance system. 
 
Inequality widens faster if not checked in time. If the fiscal and monetary policies are not aligned and aimed at growth and price stability simultaneously, inflation gets incentivised, like a little poison to spoil the food. 
 
The country is fortunate to have all the potential with the best of human resources to skilfully manage other resources abundantly available in the form of natural resources, technology, brainpower, support systems like good culture, values, ethics and all ethos needed for making the economy a superpower. The readiness to move forward without any negative thoughts and actions is all that matters. 
 
To end this write up, I would like to quote our famous cartoonist RK Laxman, on the issue of price rise: "True, our reforms have caused inflation, unemployment, increased debt, and sent prices soaring. But you will be happy to know that we have taken all these into account. We had to increase the prices on account of the fact that the cost went up because we put up the prices which was due to our hiking the prices". (The best of RK Laxman page 50,51)
 
As the taste of the pudding is in eating, the result of various measures to contain inflation is to be judged from the people's happiness in procuring essential consumption items for survival within their affordability.      
 
(Dr TV Gopalakrishnan is retired chief general manager of Reserve Bank of India-RBI)  
Comments
mgwarrier
3 months ago
The article is well structured and written in a language without complicated economic jargons or quoting research figures. Whom inflation affects and who benefits from uncontrolled inflation are also brought out clearly. It is also stated with no ambiguity that there's a felt need to take a diversion from traditional inflation control strategies. The new approach will include drastic changes in taxation policies and resources management. This much in response to Chandragupta's online comments. To be specific :
New avenues to mobilize more revenue need to be tapped without hesitation : Taxing Agricultural Income beyond a threshold level, reintroduction of wealth tax, expenditure tax on certain types of luxury expenditure are all areas open for exploiting.
The point is, the inflation elephant cannot be managed by bimonthly statements from RBI alone. Conscious policy intervention from GOI after arriving at national consensus is the need of the day. Tapping idle domestic gold stock will ease pressure on foreign exchange.
gopalakrishnan.tv
Replied to mgwarrier comment 3 months ago
The Govt and RBI need to consult each other and arrive at the measures to augment revenues which are non inflationary in character. For example Security Transaction Tax introduced in the year 2004 is non inflationary and cannot affect the items of consumption in any manner. Similarly conversion of Unproductive Gold into cash cannot add to the inflation as such although money supply may get increased. But there are ways to contain / restrict that sort of inflation. Bank Transaction Tax if introduced for high value transactions without any possible reflection on the Corporate balance sheets can be another example. The need to have a thorough watch on expenditures getting added to cost of production cost of transportation and marketing to contain inflation is paramount as all sorts of malpractice not captured ie camouflaged get added to the cost and passed on to the consumers. There are ways but the intentions are missing.
yerramr
3 months ago
Dr TVG has bundled his experience as a central banker and senior citizen in the article. Value of rupee instantly goes down with the inflation rising. The whole world is under the seize of inflation owing to the rise in oil prices and the unending war between Ukraine and Russia. He seems to have ignored the fact that most state governments have been indulging in competitive populism. The average amidst the poor are riding on free money paid from the taxes of the middle class and most rich avoid or evade taxes through the efficient services of tax consultants. It is the middle class that is worst hit by inflation and who cares for them?
chandragupta
3 months ago
I don’t understand what is the point of this article. Sounds like an endless rant against all and sundry. Every one knows what the problems are. Please give some practical suggestions which can be really implemented in a democratic setup like what we have in India, with all its political, bureaucratic and judicial constraints.
skgupta876
3 months ago
Respected Sir,

I beg to differ on two counts.

One, the equality of income is next to impossible in any economy, not to talk of the Indian economy.

Second, the author suggesting taxing the people belonging to all segments, may be a wishful thinking only. Could any FM ever dare to bring the agricultural income under tax net?

Mind you, as is well known, the basic economic theory, including the Theory of Inflation, is based on some assumptions, which may or may not hold good in any given situation.

Anyways, Thanks a lot for highlighting several ignored, unspoken yet glaring facts pertaining to the upward looking inflation (both the WPI and CPI) as of now. It's different matter that even the same is being justified under various alibis.

Srinivasan TP
3 months ago
Very well written article. I liked the fact that Dr TV Gopalakrishnan chose to highlight two important perspectives that are generally ignored by most coverage on inflation -

1. "Even a one rupee increase in his expenditure without a matching rise in his income affects him financially, emotionally and psychologically ." - it is important to understand that if left unchecked, inflation is dangerous enough to break the social fabric of our country

2. "Inequality widens faster if not checked in time. " - This is an extremely important point that somehow gets completely missed by many experts in this domain. Inequality grows exponentially if not checked in time, and it would be a complete disservice for our future generations to leave a playing field that is uneven at so many levels and with inequalities that are so deep.

This article is a must-read for all decision makers.
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