Inflation (rumblings)..

Well let me start by saying what Freidman said "Inflation is always a monetary phenomena". Due to excess liquidity available global as a result of low interest rates in all countries, the stage could be set for inflation worldwide which is not a case currently. US is still experiencing sub-normal inflation and the same is case for European countries.

The argument that if the world prices are high, one cant cut down on domestic inflation is basically proxy for the argument that the whole world is a giant connected market with free flow of capital and trade. Hence even if domestic interest rates are increased, there will be large influx of capital. This will either (lead to appreciating the currency, hurting exports and hence GDP) or (increase in forex reserves -> high inflation) . This is a major concern currently as even though there are inflation concerns in Brazil and Australia and they have raised rates, but some country like Brazil had to impose capital controls in order to control appreciation of the currency.

But after saying that, the Indian Market is not so integrated with world capital markets that the rise in interest rates in India will have no effect on underlying domestic inflation. We in India and China to some extent are facing a much higher inflation compared to US, Europe which would not have been the case if the world has been flat.

The other aspect of monetary policy which I guess have become a big issue now whether there is broad based or sector specific inflation. This is taking the same logic from international to sectors. Due to sector specific distortions like government taxes, incentive etc, infrastructure etc, there could be inflation in specific sectors or specific geographies. One would like the central bank NOT to play the role of stocks speculator and decide whether some specific sector is inflated or not because that is complicated, impossible to do and would lead them to favor one over another. It is expected that they look at broad inflation numbers and do a good job in managing growth along with maintaining a growth target. This aspect is currently being questioned though in light of housing crisis. Whether the central bank has the duty to identify the inflation/bubble and prick it or it is too difficult task and hence they shall not intervene. My view is that they shall not do it but I guess one can differ. It is about accepting small positive changes or large changes with variation on both sides.

Now coming back to current changes by RBI, this certainly is not geographic specific inflation. Is this a sector specific inflation? Well I am not so sure about it. I will see if I can dig some data for this.