We are all structuralists, knowingly or unknowingly.
Adapted from Molier, The Would-be GentlemanOver the last one decade inflation in India has been due mostly to oil price shocks or below normal harvests; only in 2006–07 did aggregate demand pressure seem to play a role in raising the general price level. Inflation originating in supply shocks is generally transitory and represents a movement from one equilibrium price level to another. Only when aggregate demand exceeds the economy's production potential and the monetary policy is accommodative can inflation be of a continuing nature. The two types of inflation call for quite different policy responses. Anti-inflationary fiscal or monetary measures are required when there is an excess demand situation, not when there is a sectoral shock. Nor are policies like oil price freeze or cuts in customs-cum-excise duties on cement or metals appropriate for containing an increase in the general price level: such measures are distortionary and counterproductive in as much as they reduce the country's full employment output and growth potential. Only in the case of shortage of food and other essential items of poor men's consumption is it necessary to undertake supply side management through reliance on PDS as well as open market sale of foodgrains by FCI.
The purpose of the present paper is to examine the nature of supply and demand side factors causing inflation in the Indian economy and the efficacy of alternative anti-inflationary measures. In order to motivate the discussion we summarise in Section I the main features of two recent inflationary episodes with special reference to their official diagnosis and the policies pursued to reduce the price pressure. In the context of this survey we pose in Section II some theoretical and policy issues which appear important, but do not seem to have been properly addressed. Sections III to V attempt at a resolution of these issues and provide in the process a critique of the anti-inflationary policy response of the fiscal and monetary authorities. The final section concludes.
