Tolerance of inflation

Amartya Sen has argued that famines do not take place in a democracy because a free Press alerts everyone to the problem, and governments are therefore forced to act before it blows up into a crisis. Given the experience with battling inflation in the last few months, the same might now be said with regard to inflation""an active market system and informed public debate prevent inflation from getting out of hand because a rising price graph is matched by a rising crescendo of criticism, thus forcing the government and the monetary authority to take action. Indeed, this might explain why the system's tolerance level for inflation has dropped from the 10 per cent threshold in the 1970s and 1980s, to 7-8 per cent in the 1990s and now to about 5 per cent. Recall that inflation had reached the 15 per cent level in the mid-1990s before the government and the Reserve Bank cracked down. It is inconceivable today that any government will be allowed to wait that long before it is forced to take action.

The jury may still be out on why and how the inflation graph has been brought down from the 7 per cent level that it had reached earlier this year, to 4.8 per cent now (for wholesale prices). There are those who argue that monetary policy has had little to do with it because all it needed was for the agricultural cycle to work itself through from one year to the next. But if it is accepted that there was evidence of over-heating in the system, then it must have helped that interest rates were raised in quick steps and liquidity also curtailed. The government, similarly, had to respond with what measures it could take by way of augmenting supplies through imports, and by lowering taxes.

It is reflective of the heightened sensitivity to inflation management that the Reserve Bank has moved from a half-yearly policy cycle to quarterly pronouncements, with mid-step corrections also becoming fairly common. And the rise of the private "commentariat" must surely be a factor in this. Indeed, the promising development of recent months has been the benchmarking of Indian inflation with levels in the more developed economies, with questions being asked by the "commentariat" as to why inflation here too cannot be pegged down to about 2 per cent. Where this is headed therefore is a situation where the RBI will be called upon at some stage to ask and answer that question. In short, the tolerance level for inflation may be about to drop further. Among other things, that will call for more reliable measurements of price levels, so that monetary decisions are based on better information flows.