It argues that short-term monetary tools to address inflation caused by supply constraints may be counterproductive. This suggestion raises some crucial issues.
First, it is true that monetary policy is a tool for demand management and it has no influence on an increase in food inflation. However, monetary policy has a critical role in reining in the "second-round effects" of high and persistent food inflation. If a supply shock is transitory, then it is not a major concern and monetary policy can look through it because the elevated inflation (due to a supply shock) will fall back to the initial level once the shock abates. Also, monetary policy operates with long and variable lags (typically more than a year).
Therefore, before its impact is felt, inflation could drop to its initial level.
However, if a supply shock persists, there is a risk of high food inflation spilling over to headline inflation through the wage-price spiral, as the public begins to incorporate higher food inflation into their expectations. This risk of "second-round effects" increases if high food inflation persists for an extended period.
India often faces supply shocks for one food item or another. Also, food inflation in India has a disproportionate impact on inflation expectations of households because it is experienced on a day-to-day basis, unlike headline inflation.
This story is from the August 07, 2024 edition of Business Standard.
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This story is from the August 07, 2024 edition of Business Standard.
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