Change in inflation behaviour

October 17, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

Since the beginning of this year, particularly after May, there has been a visible change in the behavior of inflation. In the food sector, it has slowed down; in the industry sector, it has picked up. The latter is the secondary effect of food inflation coming through cost of production in industry.

Inflation had started with vegetables in March 2009. At first, it looked rather harmless as if it was a temporary mismatch between production and demand. But soon inflation galloped, engulfing other food articles like milk, fruits, edible oils, meat and eggs. By December, food inflation had climbed 19 percent. That was because the demand-supply mismatch was not temporary but generated by changes in consumption pattern. There has been a partial shift from consumption of cereals to consumption of non-cereals, the supply of which was not elastic enough to catch up with inflated demand.

Understandably, the monetary policy the RBI used failed to control inflation. The demand for non-cereals is interest inelastic. People don’t buy milk or fruits and vegetables from money borrowed from banks. With no change in policy, the government and RBI allowed food inflation to survive the last two years.

What is significant is food inflation spreads. Wages in industry or salaries in government are linked to cost of living in which food has 50 percent weight. That makes a corresponding increase in wages and salaries automatic. Costs in industry shoot up and are passed on to the consumer through higher prices. Apparently, it takes about a year for food inflation to be transmitted to the industry sector. That is what has made a change in the behaviour of inflation since the beginning of this year.

The pace of headline inflation in January-September was the same as in these months of 2010, partly assisted by increase in the administered prices of fuel and power. But food inflation and industry inflation behaved differently. In these eight months, food inflation in 2011 was only 2.1 percent; in industry it was 4.3 percent. Prices of manufactured goods were rising twice as fast as prices of food articles. In 2010, it was an entirely different story. Food inflation in January-September was 9 percent and in industry 2.2 percent. Prices of manufactured goods were increasing at one-fourth of the rate of food inflation.

Does the change in the behaviour of inflation call for a change in policy? Inflation in industry is not due to excess demand but excessive costs. Cost-push inflation cannot be checked by measures that curb demand. For industry will not sell below cost. When demand is checked production is cut, not prices. That is exactly what is happening.

The main cause of inflation persists. It will take some time for the market to bring a balance between demand for and supply of non-cereals. But the government can help shorten the time by extending facilities for increased production.

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food inflation spreads……….yes it does….

Posted by Robertla | Report as abusive