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The real reason why inflation won’t go away Form pvvg swamy

September 13, 2014
Inflation so far experienced cannot be brought down but future inflation can be brought under control by controlling money supply which only the government can enforce. This can be done most simply by cutting down all subsidy schemes and government expenditure. People will automatically stand to benefit once prices stabilise at around a particular level.
To enable itself to have control over the existing money supply, the government should demonetise all high denomination notes (Rs.1,000 and Rs.500) and ask all the holders to turn in the existing notes to their accounts in banks. Subject to certain conditions, a tax rate of 20% should be withheld by banks and remitted to government. In due course, the holders should explain how they got such money first. If the money is ill-gotten, all of it should be confiscated. As a followup measure, RBI should print only lesser denomination notes from Rs.100 downwards. So all transactions will be through banks only and government can investigate the accumulation of money by holders even later, not necessarily in the same financial year. People who still indulge in bribegiving and bribetaking will have to carry large amounts of cash, making them subject to great  inconvenience as also easy detection and capture..


The real reason why inflation won’t go away

” Inflation is always and everywhere a monetary phenomenon.’ 

This was the famous statement made by the Nobel Prize winning economist Milton Friedman.
 It basically means that the real cause of rising prices is an increase in the amount of money supply. When applied to the Indian context, it can help explain why prices never seem to come down. Allow us to explain. 

Without getting too technical, Friedman’s statement simply means the following. Whenever, the quantity of money in an economy increases faster than the GDP prices will rise. This, we believe, is the real long-term cause for structural inflation.
Here we are not referring to the short-term spikes in food prices due to hoarding or the delayed monsoon. By ‘structural inflation’ we mean a general rise in the price level. After all, what does a movie ticket have in common with pulses? Nothing at all but the prices of both has multiplied over the years. This cannot be due to bad weather, high oil prices or speculators. Nor can it be explained by wars in the Middle East.
The real reason is the supply of money which has increased over the years at an annual rate above 15% for several decades. The Indian economy, on the other hand has grown at a far slower rate. This has led to a constantly rising cost of living in the country. 

Now we all know that the US government has run huge deficits for several years. The US fed has helped out by printing money whenever needed. The Quantitative Easing (QE) policy is just an example of this.

But what about India? It is interesting to note that the Reserve Bank of India (RBI) has funded more than one-fourth of the government’s borrowing program in the last few years. Why is this important? Well, this money from the central bank has helped the Indian government spend far more than what it could have otherwise. It has allowed the government to transfer huge amounts into welfare schemes. A lot of this money was siphoned off and never reached India’s poor. Thus the quantity of money kept on increasing at a much faster rate than India’s growth. This has led to India’s structural inflation problem. So does this mean that the RBI must share some of the responsibility for this? We don’t believe so. 

In India, it is the government that decides how much it is going to borrow. This amount of borrowing in turn will determine the increase in the quantity of money. Thus, unless the government gets a grip on its own finances, the money supply will go on increasing. Short-term measures like tinkering with customs/excise duties and imposing the Essential Commodities Act on speculators will not solve the problem.

The RBI governor Raghuram Rajan has quite rightly stated that India must solve this structural inflation problem as soon as possible. Otherwise, the cost of living for the common man will keep increasing year after year. Even corporates will not be spared. Structural inflation tends to last across the entire economic cycle. During periods of high GDP growth, even firms with poor pricing power will do well. However, when the down turn hits, only the most cost efficient firms with strong pricing power will survive to create long term wealth.
So far the Modi government has shown its intent to control spending but we haven’t seen many concrete measures being implemented. History will remember the previous UPA government as a failure on the inflation front. We certainly hope that this government’s legacy does not end up the same way. 


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