Inflation

The widespread attribution of inflation to supply-side factors permitted policymakers to escape criticism from their overly expansionary past. This article demonstrates that the inflated monetary base drove up the prices and contextually analyses a variety of policies to remedy this.

It is argued that a key question of the operation of monetary policy is its decomposition into a price effect and an output effect. Specifically, the
association between the easing of global monetary and liquidity conditions on the one hand, and the significant spurt in inflation, on the other, in recent
times is probed to conclude that across the world, there seems to be an association. The issues of monetary stability, price stability and financial stability are also intimately interlinked.

Following the standard percepts for dealing with supply shocks, monetary policy continued to be easy for an extended period, while simultaneously huge fiscal stimuli were applied. Even when a more restrictive monetary stance was taken, the measures were not strong enough to restrain inflationary expectations. A soft monetary policy with a sizeable fiscal deficit can harden inflationary expectations and a perpetuation of a new higher normal for inflation.

A public interchange among some leading macroeconomists suggests a change in the way inflation is perceived by the profession. It is increasingly being recognised that inflation can be the outcome of a conflict over income, reflected in the continuous attempt by the firms to raise prices and by the workers to raise wages in order to gain a larger share of it. At least some part of the inflation in India can be seen as a conflict over income shares and sketches a theory of inflation suited to its economy. Against this background, the effectiveness of inflation targeting is touched upon—the inflation-control strategy of the Reserve Bank of India—and the necessary steps to curb inflationary pressure in India are pointed out.

Inflation-targeting central banks supplement their monetary policy announcements with communication in the form of speeches and publication of text documents. The markets react to the surprise component of the rate action and the communication by the central bank. Thus, the monetary surprise derived from the reaction of markets, following a policy announcement, is agglutinated with the central bank information. The present paper attempts to identify and examine the efficacy of such an information shock in influencing the inflation expectations of households, interest rate expectations of agents, output and inflation.