Cost and benefit of disinflation policy in India

Abstract

Current monetary policy stance is based on assertions that there is no trade-off between inflation and growth and that disinflation will result in more growth. Present study examines recent empirical evidence on India for the direction of causality for growth and inflation, and short-run costs and long-run benefits likely for the deliberate policy of disinflation. There is no support for the first assertion because the regular trade-off does exist in India imposing substantial short-run costs for deliberate disinflation. There is a stronger evidence for causality from growth to inflation, but the reverse causality cannot be ruled out. Disinflation may result in the gain in long-run growth after 4 to 5 years. Under such conditions, RBI should hold nominal growth of money supply and allow supply side policies by the government to bring down the inflation.