 "inflation, vegetables")
By front-loading rate hikes, the RBI can cement the credibility of its monetary policy intent and action when it fights supply-side driven inflation on one hand and also contains the negative impact on growth, as per an article.
The paper has been authored by three RBI analysts, including Deputy Governor Michael Debabrata Patra who is a member of the rating setting panel Monetary Policy Committee (MPC) and also heads the key monetary policy department at the central bank.
The article has been published in the monthly RBI bulletin for July but does not officially represent the views of the monetary authority.
Underlining that the current inflation pain is global and supply-side driven and can better tackled by fiscal measures and not monetary policy actions like rate hikes, the article notes that the ongoing supply shocks are larger and unrelenting, carrying the risk of "unanchoring inflation expectations".
They are also accompanied by a rebound in pandemic related revenge spending, leading to a gradual closing of the output gap underway.
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Therefore, coordinated monetary and fiscal policy responses are needed to tackle this because "given the limited policy space, frontloading of monetary policy actions can keep inflation expectations firmly anchored thus maintaining the credibility of the central bank, re-align inflation with the target and reduce the medium-term growth sacrifice," says the article penned by Patra, Joice John and Deepak Kumar.
The article squarely pins the blame for the ravaging global inflation pressures on crude oil prices and the resultant ripple effect on rates of other commodities following the Russian invasion of Ukraine.
Using crude prices as an exemplar of supply shocks, simulations from the RBI's quarterly projection model show that when the shock is transitory, inflation returns to equilibrium without the need for any monetary policy action.
On the other hand, repeated supply shocks trigger second round effects through cost-push, inflationary expectations, exchange rate volatilities and demand channels, warranting pre-emptive monetary policy action.
"Lack of credibility can reduce the monetary policy response even and therefore by frontloading monetary policy actions, credibility is demonstrated by showing commitment to the inflation target.
"The required monetary policy response is lower when there is a fiscal policy response to supply-side shocks, but the latter entails macroeconomic costs, including potentially a slowing down of medium-term growth," says the article.
If the central bank is seen credible with its intent, words, and actions, then timely monetary action can prune the long-term impact on growth, it added.
The article also quoted the World Bank which has pegged global median inflation at its highest level since 2008. For advanced economies, it is at its highest level since 1982 and in the US it is at a 41-year high.
This inflation surge draws its origins from a series of supply shocks---pandemic lockdowns, supply chain disruptions, elevated commodity prices and the war in Ukraine.
The energy component of global consumer price inflation is at its highest level since early 1980s. For over 40 per cent of emerging markets and most low-income countries, consumer price index and food inflation is expected to remain in double-digits through 2022.
Consequently, the global inflation crisis is just the face of one of the most severe food and energy crises in recent history that now threatens the most vulnerable across the globe, it added.
In a world wherein elevated inflation is globalised, "it is the direction of the change that matters, not the height" and central to that exercise is the "role of credibility of the monetary policy and anchoring of inflation expectations."
Higher crude price increases other international commodity prices, feed into global inflation and weaken global demand and growth.
The direct impact of higher crude price on inflation occurs due to the pass-through to domestic petroleum product prices. Second round effects occur through cost-push -- petroleum rates increase prices of intermediate goods and services which, in turn, push up prices of final goods and services.
There is also a demand channel of transmission to domestic inflation at work -- higher fuel prices reduce consumption of other items and profit margins of firms, leading to lower cash flows and investment.
If crude price increases by 10 per cent, inflation can rise by around 30 basis points at its peak, with GDP growth weaker by 20 bps. Hence, monetary policy tightening is required to push inflation back to target, it added.
The monetary policy reaction widens the output gap, compresses demand and thereby brings down inflation. On the other hand, if fuel taxes are cut by 10 per cent, inflation can decline by around 15 bps and GDP can gain by 20 bps, the article said.
(Only the headline and picture of this report may have been reworked by the Business Standard staff; the rest of the content is auto-generated from a syndicated feed.)
