The fear that the recent rise in the inflation rate will scupper their chances of re-election has led the United Progressive Alliance government to blame the usual suspects: hoarders, monopolists, and of course, foreigners. So bring back discredited policies: raid hoarders, torment speculators and ban export of agricultural products.
But raiding merchant's stocks and banning forward training merely short-circuits the inter-temporal smoothing mechanism -- whereby traders make a profit by buying stocks when prices are low, and offloading their 'hoards' when prices are high.
Preventing farmers from benefiting from current high world prices for commodities, apart from not allowing them to become richer, also reduces their incentives to raise supplies.
Even the purportedly economically literate finance minister has accused the domestic steel producers of monopolistic practices, when in the global economy their share (and hence control) of output is small, and hence it is inconceivable that their output decisions can influence the world price of steel.
Then, foreigners can be blamed for the high price of commodities, leading to cost-push inflation. This harks back to the Latin American 'structuralist' views, which claimed that as money prices of individual goods and services were sticky, any relative price change could only occur through price rises and thence inflation.
This view was thoroughly discredited and the old classical view that inflation is largely a monetary phenomenon was widely accepted around the world. It is this 'monetarist' view of inflation which blames a presumed loosening of monetary policy by the RBI, which is now being reversed by the recent rise in the repo rate and the higher reserves banks have to hold with the RBI.
Prima facie, there seems much to commend this view. In a recent paper for the NCAER (Lal, Bery, Parida: "The Australian Open Economy Model and Macroeconomic Outcomes: India 2001 to 2007-08) it was found that whilst, till 1998-99, the monetarist model seemed to explain the behaviour of the RBI pretty well, since then it has broken down.
This is largely because since then it has engaged in massive sterilisation of foreign inflows to prevent the rupee from appreciating. But, in itself, just looking at the increase in reserve money does not tell us the net effects of the monetary and fiscal stance of the authorities on nominal aggregate demand and thence on the price level.
We need what economists call a 'general equilibrium' model of the economy, where everything is interconnected and the effects of the change in one particular aspect affect myriad of other variables. As I have argued previously, the so-called Australian model of a small open economy provides such a model.
In this model, the domestic price level can be decomposed into two broad groups of commodities. The first are "traded", whose domestic prices are set by the foreign currency 'world' prices and the nominal exchange rate (Rs 1=$x). The second are 'non-traded' (like housing, infrastructure and domestic services) which cannot be exported or imported, as well as goods which could be, but because of administrative controls (as for oil)