Prices,policy rates

The Reserve Bank has hinted that an increase in prices of protein items such as meat,eggs,dal and milk will push up food inflation and it may have to raise interest rates in response. It is welcome that the RBI is now responding to expectations of higher inflation rather than simply responding to past inflation or trying to push the blame away. But theres a long way to go before monetary policy can successfully anchor inflationary expectations and curb inflation.The issue under debate is whether monetary policy should respond to a rise in food inflation. One perception is that a rise in food prices is only a change in relative prices,and not a general rise in prices,thus monetary policy should not respond. Another is that food prices cannot be controlled by interest rate increases,and are a subject of supply management. There are,however,strong arguments in favour of monetary policy responding to higher food prices. These are specific to the Indian context. When expenditure on food is a very small component of total household expenditure,as in advanced countries,then it can be argued that an increase in protein prices has nothing to do with monetary policy. In India,food forms a large share of the consumption basket of the bulk of the population. As incomes have been rising,the demand for protein items compared to cereals has increased. Supply has failed to respond adequately despite higher prices due to the lack of infrastructure such as roads and cold storage chains,policy that subsidises production of cereals,lack of marketing facilities,seeds and other support given to cereals. One option is what the RBI followed until recently that is,to argue that this is a supply management issue and monetary policy need not respond to it. This,however,has resulted in rising food inflation,feeding into higher wages,higher inflationary expectations and higher inflation.As one of the few countries facing high inflation in the post-crisis period,with high output growth and high inflation,India needs to take steps to curb inflationary expectations. The RBI will have to tighten monetary policy and communicate clearly that itll not tolerate an inflation rate of above a certain target.