The Economic Times is India's leading financial newspaper. Today it carries an editorial on India's current fight against inflation. But lessons drawn in the editorial apply far more widely than only India.
Regarding India itself the Economic Times notes that the wholesale price index, used as the country's benchmark inflation rate, has risen to 8.6% in January. It however believes that this number is so far not as serious as it appears at first sight as it is based in short term pressures on food prices, worsened by the very poor 2009 monsoon, and upward price shifts that have appeared in some manufacturing sectors, But it concludes: 'That said, the threat of core inflation accelerating in the months ahead as economic activity and demand pick up, remains.'
In the light of this latter consideration the editorial, regarding monetary policy, supports the tightening started by India's central bank raising reserve requirements in January. Regarding fiscal policy the editorial argues the Indian government must contain the budget deficit and 'reallocate expenditure away from consumption towards investment,'
This means that the Economic Times understands the general fight against inflation more accurately than do some other commentators. Containing inflation requires measures not only on the demand side (tightening monetary policy, preventing excessive budget deficits) but also on the supply side - increasing supply by removing capacity constraints. Removing supply side blockages requires investment - hence the correctness of the editorial's call for a shift of expenditure from consumption into investment,
When capacity constraints are appearing in an economy a policy only of increasing consumption, which by definition does not add to capacity/supply but only to demand, is inflationary. Investment, which adds to supply as it comes on stream, on the contrary strategically contains inflation by removing capacity constraints.
The country to which this point applies particularly clearly at present, in addition to India, is China. China has seen the emergence of clear inflationary capacity constraints. Some commentators have been calling for China simply to increase domestic demand by increasing domestic consumption and not also to increase domestic investment.Such a policy of increasing domestic consumption, without an increase in investment, under conditions of capacity constraints, would add to inflationary pressures.
The Economic Times editorial is correct on this point regarding India. But it also applies to China.
This issue is of great importance in looking at the present economic situation in both China and India and this blog will be coming back to it. Meanwhile the Economic Times editorial deserves consideration more widely than only in India.