How to contain inflation?

Before I get into the steps needed to control inflation, I'd like to point out that the current methodology for calculating the CPI has some limitations that can affect the accuracy of the inflation rate it represents. Some of these flaws are as follows:

The CPI basket of goods and services is based on outdated consumption patterns from the Consumer Expenditure Survey (CES), which is conducted on a periodic?basis. Because spending habits change over time, especially in a country like India where the economy is growing rapidly, an old basket may not accurately show how people spend money now, which could lead to an inaccurate measure of inflation.

India is a diverse country with large regional differences in consumption patterns, preferences, tastes, and prices. In such cases, the national CPI may still fail to capture the inflationary experiences of different regions, resulting in disparities in the perceived impact of inflation.?

The CPI is intended to track changes in the prices of goods and services while maintaining their quality. On the other hand, accurately accounting for changes in quality over time can be challenging. If quality gains are not fully taken into account, the CPI may overstate inflation because consumers may be getting better products at higher prices.

The CPI assumes that consumers will continue to buy the same basket of goods and services even as prices change. In reality, as prices fluctuate, consumers may substitute cheaper goods for more expensive ones. This substitution effect can cause the CPI to overestimate inflation. Because the basket is only updated on a periodic?basis, the CPI may not accurately reflect the impact of new goods and services entering the market. The introduction of new products, particularly those that replace older ones or alter consumption patterns, can have an impact on the CPI's accuracy.

The CPI assigns weights to various components based on their relative importance in the consumption pattern of the average household. If these weights do not accurately reflect current consumption patterns, the CPI may not accurately represent the average household's inflation experience.

Now, the burning question is: How to contain inflation?

The current retail inflation rate is 6.44%, and the wholesale inflation rate is 6.50%, both of which are higher than the Reserve Bank of India's target range of 4% with a +/- 2% tolerance. India can consider implementing a combination of monetary, fiscal, and structural measures to control inflation and bring it down to a more comfortable level:

Monetary policy measures: The RBI can tighten its monetary policy to reduce inflationary pressures. This could entail raising the policy repo rate, making borrowing more expensive, and discouraging excessive credit growth. In addition, the RBI can use other tools to manage liquidity in the financial system, such as cash reserve ratios (CRR) and open market operations (OMO).

Fiscal policy measures: The government can implement prudent fiscal policies to control inflation. The government can help manage demand-side price pressures by reducing fiscal deficits and prioritizing spending on productive sectors. Subsidy reforms and better targeting of social programs can also help to keep inflation under control by reducing fiscal imbalances.

Supply-side measures: Supply-side constraints, such as agricultural output shortages, infrastructure bottlenecks, or disruptions in global supply chains, can often drive inflation. The government can invest in increasing agricultural productivity, improving storage and distribution infrastructure, and enacting policies that encourage industry efficiency and competition. If my memory serves me correctly, a third of agricultural products today are wasted before they are consumed. This needs to be addressed.

Exchange rate management: Currency fluctuations can have an impact on inflation, especially in an import-dependent economy like India. The RBI has the authority to intervene in the foreign exchange market in order to stabilise the exchange rate, thereby minimising the impact of currency movements on domestic prices. Policy goals and guidance for the future should be made clear so that inflation expectations can be set and prices can stay stable.

Structural reforms: Long-term structural reforms can help improve the economy's overall efficiency and resilience. Reforms in labour markets, land acquisition, and business ease can all help boost productivity, increase the economy's potential output, and reduce inflationary pressures over time.

Monitoring and coordination: To ensure a coherent and effective response to high inflation, the government and the RBI should closely monitor inflation trends and coordinate their efforts. Timely data collection and analysis can aid in the identification of emerging risks and the development and implementation of appropriate policy measures.

It is important to note that these measures must be carefully calibrated and tailored to the specific inflationary drivers in the Indian economy. Maintaining overall macroeconomic stability and achieving long-term development goals requires striking the right balance between controlling inflation and supporting economic growth.