Effectiveness of monetary policy to control inflation in India

Rajesh. R Financial economics Madras School of Economics

INTRODUCTION
Inflation is a major obstacle to achieve high economic growth in the modern economy. Policy makers are working hard to bring down inflation through monetary and fiscal policies. In India inflation has been a big worry for policy makers they have been working effectively to control inflation.

Monetary policy is an effective tool if inflation arises due to excess demand but inflation arises due to cost push factors then monetary policy will not be an effective tool to control inflation

Objectives
The main objective of this study is to find out the supply side factors affecting inflation in India and the effectiveness of monetary policy to control inflation

This paper based on cost push theory of inflation

Cost push theory of inflation deals with variable which influence inflation other than monetary expansion.
Though strong correlation between inflation and monetary expansion will clearly explained that inflation is a monetary phenomenon but there are other factor which influence inflation like supply shocks, Cost of production and exchange rate.

Inflation and policy responses

Inflation in India becomes major issue when food prices started to raise abnormally. Sudden raise in food product , crude price and exchange rate Made the inflation on the top. RBI has hiked its key policy rates 13 times, totally 350 basis points, since March 2010 to tame demand and curb inflation. The rate of price rise has been above the 9 per cent mark since December 2010.

Policy responses from 2010 to 2012

Consecutive figure
12

10

6 inflation repo 4

Data source RBI

Inflation and agricultural production

Increase in the production of agriculture products will reduce the inflation sharply. In the whole sale price index has more than 20% wait for agriculture to calculate Its index. In the period of 1960 to 70 agriculture production has started to increase Quickly helps to reduce inflation more than expected.

Industrial production and inflation

Manufactured goods are having more weight in the calculation of WPI. Not only does rising inflation hit the costs of companies, via increases in price of inputs, it also limits the pass on of prices to consumers who are already spending less on discretionary products. Rising prices of essential commodities like food and fuel means that consumers have less to spend on other goods. As a result, consumer non-durable goods production has actually shrunk

iip growth
14

12

10

iip growth

0 1 -2 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

-4

-6

Exchange rate and inflation

Since credit crisis in European countries widening demand for American dollar has been increasing it leads to continues appreciating in US$ and Indian currency Has been depreciating. Depreciation in rupee will make our import costlier than Before . We are importing 70% of our oil consumption from abroad and we need to Pay in terms of US$ so currency depreciation will make our import costly and this increased cost will spread to other consumption goods.

exchange
60

50

40

30
exchange

20

10

Oil price and inflation

Since demand for crude increased drastically price for crude also increased In the same manner. Oil is one of the main raw material for most the manufactured Goods thus increased oil price will reflect in the cost of production. If the cost of Production increased then price of the final goods also will get increase. Thus oil Price hikes will increase the cost of production and high cost of production will lead to increase in the price level.

oil price
120

100

80

60

oil price

40

20

methodology
y= x1- x2-x3-x4+x5+x6
y= X1 = X2 = X3 = X5 = X6 = Inflation growth in index of agriculture production growth in index of industrial production growth in exchange rate changes in oil price repo rate

References
KC CHAKRABARTI(1978) INFLATION TRENDS IN INDIA

In this paper author tried to explain the cost push factors which heavily influence inflation in India. Though he had Valid arguments his statistical numbers hasnt support to His paper. Price level = +x1+x2+ x3 X1 is rate of change in agri production X2 is rate of change in industrial production X3 is rate of change in money supply

Work in progress
Statistical relationship between variables and statistical evidence to support my project, data collecting and some theory based work.