Why is RBI unable to control inflation?

Tue, 5 Feb Pre-Open

   Previous Close   

   09:30 am   

   11:30 am   

   01:30 pm   

   Closing   

We all are aware about the two types of inflation prevalent in the economy. One is the demand pull inflation and second is the cost push inflation. As the name suggests, demand pull inflation is caused by excessive demand arising from high liquidity while cost push inflation is a result of increase in basic commodity prices. However, there is a third type of inflation that is also relevant in the Indian context. It is known as asset driven inflation which is caused by increase in asset prices. Let us understand in more detail about it.

If the returns from any asset increase, then it is natural that the demand for that asset class rises. Take the case of real estate and gold for example. Increasing returns from both these assets has led to considerable increase in their demand and thus prices. This pushes up inflation. And considering that the demand keeps on increasing as the returns from that particular asset class are rising, it creates an inflation spiral. In short, rising return from an asset class creates a vicious circle of increasing demand and resultant inflation. The matter gets worse once speculation sets in (demands increases even further due to higher returns) as it can blow inflation through the roof.

So, how should one tackle asset driven inflation?

For that one need to understand the reason for rising asset prices. If it is driven by speculation (example real estate) then liquidity should be sucked out which chases the asset. For instance, curbing bank lending to real estate is a step in the right direction to arrest further rise in property prices. This can bring down the property price inflation.

It may be noted that interest rate tools are futile in curbing the asset driven inflation. And that is perhaps the reason why India is unable to contain its inflation despite hawkish policy being in place for quite some time. The bottom line is that interest rate tools do not impact asset driven inflation.

Also, it may be noted that asset driven inflation widens income inequalities. One needs a huge amount of capital and significant knowledge to be able ride on the speculation of gold, real estate or any other commodity. And only rich can afford such huge amounts of capital. Thus, rich get richer in this exercise, if the odds turn in their favor when it comes to speculation. It is evident from above that, if left un-checked; asset price inflation can have cascading effects on the economy.