Growth Vs Inflation - Which Should Be Targeted?

Growth v/s Inflation: Which should be targeted?

Growth or Inflation, this is a classical dilemma faced by the economists. Former Governor of RBI, Dr. Subbarao said, "There is a threshold level of inflation. If the inflation is below that level, then you can make that trade-off. But if it isn’t, then you can’t”. According to him, Inflation should be kept in check before targeting Growth, but there are others who would disagree and believe Inflation is a necessary evil while Growth should be a priority.

Growth vs Inflation isn't a question that can be answered directly, it involves so many other aspects that before discussing all of that we can't decide. The most important question being, are they even positively related? The second question being, if they are what are the other parameters that must be taken into account, who all are affected and if it has an affect on other indicators, like GDP, Exchange Rate, FDI flow.

Let’s start with the first question, are they inversely related? No, if you look at the relation between growth and Inflation in India. Let’s explain with few examples, between 2005-2006 and 2010-2011, Growth was 8.47%, Inflation being 6.55%, between 2000-2006 Growth was 6.93%, while inflation was 4.68%, between 95-2000 Growth was 5.92%, while inflation was 5.07%. If we look at these figures, it shows, higher the growth, higher the inflation. The whole point of growth vs inflation targeting, looks like a big fat myth, specially in India. Once again, if everything could be explained statistically, the world would have never seen Crashes and Recession.

In India, when we discuss Growth and Inflation, we are actually discussing the need of Poor vs The desire of Rich. Inflation hurts the poorer section of society, rise in price of food commodities, a major source of Inflation hurts the bargaining power of poor, and the price of onions rising by a few rupees might go unnoticed when you waste 1000 rs. On consumption of Pizza, but for an Indian living on bare minimum wages, it would lead to a great trade-off; he would have to give up on something to pay for the rise in price of Onions.

Growth on the other hand is more a rich man’s desire, the bank rates have to be lowered which would lead to more money in the hand of industrialists, it would lead to the nation becoming a hot spot for investors, there would be more liquidity in the market, businesses might expand and create more capital. The trickle down approach would say when the rich gets richer, the poor gets richer, but in reality, that's not a fact. Money gets concentrated in the hands of the industrialists, while the poor can’t afford basic amenities, like housing, electricity and even protein rich diet. Human Development Index, a measure of the welfare of the society gives only 1/3rd weightage to Growth or GDP, the other 66% is given to Education and Health, something Growth can never explain.

Coming back to inflation, India is a unique country, 52% are involved in Agriculture, but Agriculture accounts for only 14% of GDP, most rural poor are involved in Agriculture, in India Government uses WPI minus Food and Fuel Inflation to measure inflation, the strategy is flawed as Food Inflation affects the poor, the most. Fuel on its part affects everything, if fuel prices rise, then the cost of transportation rises which leads to increase in input price of every commodity, which eventually leads to tighter monetary policies, rupee losing its value against the dollar as you have to pay in dollars for oil. This leads to current account deficit. Rupee becoming devalued leads to increase in imports over exports, which leads to trade deficit, with inflation rising and CAD becoming unsustainable, real interest rates decrease which leads to people investing more in gold which only fuels Current account deficit. It’s a vicious cycle.

In India, Fiscal Policy is decided by the Government, which is mostly focussed on growth or rather votes. India spends a large amount on subsidies, loan waiver schemes and welfare schemes like Food Security Program or MNREGA. All this has an inflationary effect, much like deficit financing. In 2008, Government went for fiscal stimulus to maintain Growth, it flooded the market with liquidity, after a few year it had to resort to consolidation market can’t be made attractive