With the effects of the drought, foodgrains had to be imported on a large scale, at prices higher than what was paid to Indian farmers. This led to a further increase in the prices paid to farmers and an inflationary spiral set in.

More recently, clear signs have emerged that inflation in the non-food sector has picked up. This is because, even as food sector inflation has moderated (although still in the double digits), capacity constraints have been hit and inflationary expectations have become entrenched.

It is against this background that anti-inflation policy must operate. What issues are important in the current debate?

First, supply shocks are still reverberating through the economy. The initial supply shock came from the food sector, followed by the rise in prices of petroleum products, whereas the recurring supply side shock now emanates from the expected rise in inflation. The higher the rate of expected inflation, the lower will be the gap between actual and expected inflation and the smaller the resulting (positive) deviation of output from the trend.

It is in this context that combating supply side shocks becomes an essential element of anti-inflation policy. A good kharif harvest from a good monsoon might translate into a positive supply shock and lower inflationary expectations. However, such a positive outcome might be limited to being a seasonal phenomenon if food supply chains are not well managed.

Accordingly, one reads with dismay reports of the waste of existing foodgrain stocks in Food Corporation of India godowns. Putting an end to this waste will not come a day too soon. More coordinated and timely distribution of the existing grain would also be welcome. This applies also to other perishable items like vegetables and milk, large quantities of which are wasted because of the paucity of effective storage. These reforms are necessary because merely reducing demand against the background of recurring adverse supply shocks will, other things remaining unchanged, only lower output growth without having a substantial impact on inflation. The bottom line is that without tackling supply side constraints, there can be no easy victory in the fight against inflation.

Second, while wholesale price (WPI) and consumer price (CPI) inflation are statistically linked, there are enough (mutually independent) factors affecting the two that causal links can become tenuous. In this context one has to be clear about the quantitative impact and time profile of the impact of policy rates on various measures of inflation. The empirical evidence of such impacts, particularly on the CPI, is not encouraging. Jha’s recent paper ‘Inflation targeting in India: Issues and prospects’ in the International Review of Applied Economics, has demonstrated that the mean impact of the call money rate on CPI is uncertain, subject to long lags and the overall impact has a wide 95 per cent confidence interval. The extant literature has accepted that there are several reasons why interest rates may not have a straightforward relation with CPI in the context of a country like India. These reasons include: limited independence of the RBI, substantial fiscal overhang, the frequent need by the RBI to resort to other nominal anchors, and the predominance of supply as opposed to demand shocks.

Even in developed market economies, inflation targeting is facing opposition for excluding asset prices from CPI and because of the need to monitor other nominal magnitudes such as exchange rates. Thus, there is an urgent need to understand more fully the impact of policy rates in particular and macroeconomic policy in general on inflation.

In the current milieu, anti-inflation policy will work only if it is cognisant of the forces that initiate and sustain such inflation, that is, it will only work by tackling supply side issues.  Further, demand expansion from rising fiscal expenditures must be restrained. Merely raising interest rates will not help.

The current round of inflation in India is certainly a scourge.  The longer it is allowed to run its course the more devastating and deep will be its impact on the economy and society. Stabilising prices will not only have positive macroeconomic impacts, but also enhance human nutrition outcomes, thereby positively impacting productivity, resulting in a favourable supply shock.

Raghbendra Jha is Professor of Economics at the Australian National University; Raghav Gaiha is a Visiting Scholar at the Department of Urban Studies and Planning, MIT, and a Professor of Public Policy, faculty of Management Studies, University of Delhi.