"It seems necessary, therefore, to replace the traditional short-term approach normally used to analyse inflation in our countries, which mainly consists of pointing an accusing finger at conventional monetary statistics and referring to the government, the central bank and the trade unions respectively as “spendthrift”, “weak” and “irresponsible”. This type of “analysis”, which at best barely makes it possible to trace the path of inflation in the financial sphere, has never provided an explanation of the causes of inflation or of its continuing character, much less of the local characteristics it adopts in different countries." – Osvaldo Sunkel
An academic argument by Professor Pulpare Balakrishnan tends to point out that the cause, and the path, of inflation for the last three decades in India - a developing country by any metric with lots of institutional rigidities and constraints - after all, might be structural. This blog makes an attempt in taking a closer look in terms of what really constitutes the structural hypothesis. Embedded in this is a primary or a basic cause, which I will make an attempt to explain shortly, and the secondary cause, to the menace of inflation in developing economies. The title of this blog is making sense, isn't it, now. Read the title again. With this being said, I deem, in particular, the primary cause as not merely an abstract construct but, rather, a perennial problem of any developing country such as ours have to inevitably be faced with in the growth process. According to the Structuralist hypothesis, the secondary cause is nothing but only a response to the basic primary cause which sets the inflationary process in motion. Otherwise, also, known as the propagating mechanism since it only cumulatievly adds to the inflationary pressure generated from structural imbalances elsewhere in the economy. The moot point that this blog is trying to hit out is that the primary cause of inflation might not be monetarism as it is often made out to be the case, at least in the developing economy such as ours. In the Indian context, this paper by Balakrishnan and Parameswaran (2019) lays bare the significane of the structualist hypothesis to the Indian case. This conclusion of this paper starkly contradicts other papers in identyfing the causes inflation in India. Emphasising the fact that identification of causality is exceedingly important will not be an understatement since it then leads to policy adjustement. I will, however, not go in the direction of trying to point out the differences in the academic papers on alleged causes of inflation in India. The sole objective of this blog is to provide room for the coverage of the underlying mechanisms of the structualist hypothesis which I feel has not received its due attention as it rigthfully should have received. The roots of the structural explanation of inflation comes from the persistence of inflation in Latin America is the 1950s and 1960s. The demise of Professor Lance Taylor, regarded as the doyen of structural macroeconomics, HAS left a big hole that might not be filled again. Professor Ratin Roy had a piece on the Business Standard where the distinction between the mainsteam economic and the structural school has been covered concisely and draws dinstinction to the fact that structural school might hold the key to resurrect the dismal science.
As Sunkel (2016) puts it, the analysis of inflation is a two fold step. Inflation, in the first step, is generated from many points during the growth process of a developing country and those need to identified and then classified. In the second step, the analysis of the interrelationhips among those identified points can throw a more pursuaisve and a coherent picture on the cause of inflation. Firstly, there are basic pressures of inflation, as already pointed out as being the primary cause, which are driven, in large parts, due to the structural change enforced by the process of industrialisation of the domestic economy. The pressures emanate from a number of choke points during the process of industralisation in a developing economy and they have been explained below.
1. Basic or Structural Inflationary Pressure
More and more resources have to diverted to industrial sector during the growth process and this is inevitable. As this happens, the agricultural sector growth slows and, at the same, the demand for agriculture sector also picks up becasue, in general, the income level of people are rising since their productivity, due to being employed in the industrial sector, is increasing. The agriculture sector, in most developing countries including ours, is characterised by structural limitations, rigidies and inflexibilties. The compounding effect of all of these is that a demand and supply imbalance which was already prevalent is only widened. The relative prices of agriculture sector will increases and this would mean the purchasign power of people declines. In real terms, they are buying lesser and in a developing country the food and energy prices makes up more than half of the consumer price index. The supply of the agricultural produce is not keeping pace with demand and, consquently, the agricultural supply inelastic. The demand from industrial sector, however, outpaces the supply and the agriculture sector is unable to catch up. The ragged institutional and economic structure is unable to adjust and the price of the agricultural products would increase. As this happens, this puts pressure on the overall prices to go up.
2. Exogenous Inflationary Pressure and Cumulative Inflationary Pressure
In any developing economy, the exports are sluggish and the export earnings, therefore, provide no room to adjust to change. The imports cannot be increased all of a sudden since the earnings from exports are not going to rise in a giffy. With internal and external pressure, the propogating mechanism kicks into action. The fiscal and the monetary authorities are left with no choice but to respond to the price rise. This happens becasue the monetary authorities are forced to employ a bening stance to monetary policy, pumping more liquidity into the system, in order to not prop up unemployment rates which only reinforces the price rise. A loosening of the monetary policy is required to satiate the pressure of the price rise which comes through due to constraints and imbalance which is typical of any developing economy.
Therefore, for the structralist, the secondary cause where the public expenditure and money supply is adjusted is not what causes inflation. The monetarist thinks that inflation is always a monetary phenomenon and they do not take into any consideration that a developing economy has institutional rigidities that plays a role. As was pointed out, there are many links, between the agricultural and industrial sector, in a developing country which might be playing a leading role, the degree of it can vary from country to country, in causing the overall rise in prices.
Since the early 1980s, the reorganization of the conduct of monetary policy framework by the RBI has been carried out explicitly on three occasions, with the notable years being – 1985, 1998 and 2015. The latest recalibration is momentous considering that the twin objectives of “maintaining price stability” and “provisioning of adequate credit to the productive sectors of the economy” has been reoriented, somewhat assertively, to target solely the former, hereafter. That low inflation rates, apart from delivering high economic value to millions of poor individuals, would instill economic stability has been amply and intermittently documented. In recent past, the increasing application of inflation targetting by a host of developing countries has been the theme of heated polemic by Stiglitz (2008). Shrinking the exposure of global increase in prices (of oil and grains) to domestic inflation in developing countries, in an era of increasing global integration, lacks veracity, Stiglitiz claims. Interest rate increase, the potential response to counter price rise by the central banking authority, in fact, will dampen economic development and bring about higher unemployment. “Inflation Targeting...will most certainly fail” and, hence, should be discarded altogether (Stiglitz, 2008). Thus, as imminent as escalation of inflation rates will be it will also retard the practice of inflation forecast targeting of the central banking authority, especially if it is being reduced from higher levels, and, in the process, demean the central bank accountability. For this reason, it has been argued by Mishkin (2001) that the gradual adoption of inflation targetting should be pursued “only after there has been some successful disinflation” so as to bring down the likelihood of missing the inflation targets and, thereby, making it more effective. Inefficient and ineffective transmission mechanism of monetary policy in EMEs is another major drawback for inflation targetting (Mishkin, 2001). Large inequalities of income, huge employment in the informal sector, a financial sector which is still considered novice by many counts, and deficient industries development are some of the factors that might potentially deteriorate the transmission mechanism channel in the Indian case.
References
Balakrishnan, P., & Parameswaran, M. (2019). The Dynamics of inflation in India.Retrieved from http://14.139.171.199:8080/xmlui/bitstream/handle/123456789/490/WP485.pdf?sequence=1&isAllowed=y
Mishkin, F. (2001). Inflation Targeting. An Encyclopedia of Macroeconomics.
Retrieved from https://notendur.hi.is/ajonsson/kennsla2013/01ENCYC.pdf
Silva, L. A. V. (2008). A Monetarista-Structuralist Debate on Inflation. Revista Chilena de EconomÃa y Sociedad. UTEMP.
Stiglitz, J. (2008). The Failure of Inflation Targeting. Project Syndicate; The World’s
Opinion Page. Retrieved from https://www.economics.utoronto.ca/gindart/Stiglitz%20-
%20The%20Failure%20of%20Inflation%20Targeting.pdf
Sunkel, O. (2016). Inflation in Chile: an unorthodox approach. ECLAC Thinking, Selected Texts (1948-1998). Santiago: ECLAC, 2016. p. 173-194.
Wachter, S. M. (1979). Structuralism vs. monetarism: Inflation in Chile. In Short-term macroeconomic policy in Latin America (pp. 227-256). Ballinger.
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