How fair are the New Railway Ticket Cancellation Charges Rules?

The recent hike in the railway ticket cancellation charges has been disturbing and ironic (most of the charges have been doubled). The objective of such doubling the cancellation fees is that the railway board wants to “discourage” touts/agents on black marketing of tickets and to plug the scope of misuse. Apparently, the objectives are impeccable. What is wrong is the method. Notice the word “discourage” carefully. It wants to discourage agents, not punish. Why does not the board directly identify the touts and punish them? Why does not the Indian railways take direct steps to curb such activities?
Let us say for one second, that the board cannot take such direct steps either due to political compulsions or technical reasons. This is why the ministry/board is taking indirect systems to discipline the touts and help genuine passengers. Even if the ticket cancellation charge is hiked, who will ultimately pay the fine? Passengers, right? The passengers who are unaware of such complex cancellation/refund rules will still go to the travel agent. Since, it is not a penalty on such middlemen, those agents will hardly stop booking bulk tickets online. One of the stated objectives is to stop “black marketing”. How do they do black marketing? Is it that the agents buy bulk tickets online and then sell it on black market or they buy over the counter (in the railway stations in connivance with the railway countermen) and sell it later? If it is done online, then how the agents are able to issue bulk tickets? If it is done over the counter, then why are they allowed to have so many tickets?
What I am worried for is that the passengers may not be aware of such complex cancellation systems (see the chart below which is taken from here. The ordinary passenger who books tickets online and wishes to cancel due to genuine reasons will suffer and pay higher fees; whereas the agent will pay nothing. Even if they are aware of such refund/cancellation rules, if they have to cancel ticket for genuine reasons, the passenger will bear the fee. How is the new refund rule discouraging agent?
Will such “indirect” punishment help curb the rail ticket mafia? One is seriously skeptical. What if it doesn’t succeed in its objectives? What is the next solution? Raise cancellation charges again? How long will the railway board go on to hike? In its attempt to punish the touts, the railway board is, sadly, punishing all genuine passengers whom it pretends to protect.
Further, policy decision is more regressive and passenger-unfriendly. When all reserved-seats are already sold, the policy decision of not refunding money to a confirmed-ticket holder if s/he wishes to cancel for some reason is difficult to understand. Given that lot of passengers travel in with waiting tickets, what is the loss to the rail board? There is no efficiency loss. The rail ministry does not lose money. The agent or bookies do not suffer any financial loss. Only the customer suffers.
What percentage of the confirmed tickets is cancelled every day? My guess is 20 to 25 per cent. If this is so, then I suspect there is a hidden agenda behind this cancellation price hike. Perhaps, it is the easiest way to raise funds for the cash-strapped rail board. If this is so, then it is nothing less than a crime. Why cannot the ministry raise the passenger fare? Political reasons? Why should 20 to 25% of the passengers who cancel their train tickets bear the burden of raising funds when all other passengers travel? This is a glaring example of a highly regressive taxation. Is it not better to reduce the charge and raise the rail fare?
Further, it is a (in fact, bad) reform by stealth! Notice, no political party opposed to it. More importantly, there is no public protest. It also points out to an important fact: Public as such don’t have problem with rail price hike unless encouraged by the political parties.
Suggestions are in order. The cancellation charges will be dynamic and should be linked with the number of vacant seats. Further, simplify the cancellation charges. One-time fee before the train starts. And once after the train starts. Lastly, irrespective of the passenger applying for refund, the railways must refund the net of the cancellation charges to the passenger’s account. The IRCTC must have a list of passengers who did not travel. The reason is very simple: since a lot of wait-listed passengers are travelling, the IRCTC is not losing anything.

Onion Price Rise: Searching for the Bad Guy?

Everybody is commenting on India’s onion price rise. The pseudo-economist in me also urged me to comment something. So, my two cents are here.

Onion always brings tears to our eyes: When its price rises it brings tears, when its price falls, it also brings tears. So, this time when price of onion rose to Rs 61/KG, government again blamed onion hoarders and bad monsoon. It is not new thing to read government blaming price rise of vegetables to hoarders.  As usual, it is believed that government also ordered raids on godowns where vegetables are stored.

The questions are:

1.      Is it a demand-supply mismatch?

2.      Is it due to bad monsoon?

3.      Is it the hoarder, the bad guy?

4.      Finally, is it the government policy like no MSP for onion and no cold storage for vegetables?

This Wall Street Journal piece made me little uncomfortable in digesting the cause and remedial measures. For the uninitiated, without reading you can guess correctly what the article is arguing. Because the name WSJ itself is sufficient. They will say hoarders are not responsible, it the mistake of market (I mean, the demand-supply mismatch) and let the government watch the situation and let the market take care of onion price rise. Well, they say that bad monsoon and market speculations are also partly responsible. They say:

Of course, weather and market speculation play a part but the fundamental issue is a supply and demand mismatch that is causing the volatility, not an onion mafia. Demand for onions is rising along with the incomes of the average Indian. But farmers are discouraged from growing enough onions because of government interventions aimed at keeping prices down.

Hmm…..that is okay. But then they quote this:

When onion prices rise, the government steps in to block profitable exports and to knock down domestic prices, said Changdev Holkar, former director of the state-run National Agricultural Cooperative Marketing Federation of India Ltd.

I have a little problem here. If you analyze two statements here you see they talk about demand-supply mismatch and profitable exports. By profitable exports they mean export price has risen. Thus, the question is which demand-supply mismatch they are talking about: India or Global? I think it is pretty clear that they are talking global demand-supply mismatch. If this is so, then global demand-supply mismatch should be blamed for domestic demand-supply mismatch. Think of this. Suppose the demand = supply in the domestic market. But global demand > global supply. As a result, global price rises. Seeing higher price and higher profitable opportunities, domestic (Indian) producers, read TRADERS, will export more. And this will cause a domestic demand-supply imbalance. If this argument is right, then I think banning exports is a solution in right direction. Another way to think is when domestic price is rising why are they still selling in foreign market or exporting? Obviously, the export price is higher (marginally or substantially?) than domestic price. Else, they won’t export, right? If you ban exports, then traders cry foul.

The other non-trivial question is: what kind of good is onion (from a microeconomics point of view): Normal, or inferior?  

When import price becomes cheap, why do domestic corporates cry foul and urge government to ban imports or raise import prices?  Why do they do that? If due to global demand-supply mismatch (demand > supply) domestic consumers has to pay a higher price, then why do they complain when global demand-supply mismatch (supply > demand) results global price plummet and consumers also want to benefit from that? Why don’t you advise government then to tie its hand and let the market do the job?

It also argues for MSP for onion. Though, I have sympathy for this suggestion, yet the pricing or MSP hikes become more political. Some economists squarely blame food inflation to MSP hikes. They argue MSP hikes are not correlated with cost hikes and is is motivated by election. Thus, when there is a growing demand for MSP abolition of certain commodities, to what extent this suggestion (MSP for onion) makes sense has to be evaluated carefully. I leave it to you.

How to Accept (Reject) Recommendations/ Suggestions?

Suppose a book or an expert on a chosen field has set of recommendations for the government to solve a social or economic problem of the day. For example, Tony Atkinson in his book Inequality: What Can Be Done? has given 15 recommendations to solve the problem of rising and severe inequality. Or think like this. A government has instituted a commission to suggest some policy measures to solve the issue of inequality. The committee comes out with a bunch of recommendations. Now all these suggestions will be discussed and debated vociferously. It will continue for months. A government concerned about rising inequality wants to do something to reduce it.  My puzzle is this:

1.      Out of top 10 inequality experts, six experts accept recommendations #1 through #10 and reject #11 through #15. And the other four experts reject #1 through #10 and accept #11 through #15. In effect we see all recommendations are rejected and accepted. What should a government wanting to implement some of recommendations do? The question before the government is: Which one it should accept (reject) and why?

2.      In the process of intense discussions top experts in the field will reject some recommendations and will accept some. So, if there are 30 big stars in inequality research, then 15 accepting strongly all recommendations and 15 rejecting strongly how to accept those recommendations?

So, how to accept recommendations when there is a sharp divide among experts ? On what basis?

I have one suggestion. Instead of asking the experts to say yes/no, we can ask each expert to place their confidence or weights behind all suggestions. Then we will aggregate all confidence or weights. The recommendation having highest confidence will be the chosen over others for government action. Will it solve the puzzle mentioned above? It may not because when an expert says yes (no), he may give 100% weight or 90% weightage. But it will be very effective when experts are uncertain about the efficacy of recommendations. If experts give their views unbiasedly then this weighting scheme will work better.

Tax Slab, Inflation and Government Revenue

Suppose the tax slab is like the following:

(Figures in Rupees)

Tax bracket   Tax rate        Actual income  Income when indexed with inflation

0-3L                   0%                 2.9L                   3.045L

3.01-5L                10%               4.9L                   5.145L

5.01-10L              20%               9.9L                   10.4L

Start with an inflation rate of 0%. Assume that one’s income falls in the first category where he does not have to pay tax. Now inflation climbs up to, say, 5%. Assume that in the economy, people’s income/salary is tied to the inflation rate. As a result, see what happens to the fourth column. Now one’s income has shifted to tax category. For example, in the first case, as his income has risen to above 3lakhs (3.045L to be precise) as a result of salary tied with inflation, he has to pay a flat 10% income tax which is (3.045-3)*10%=Rs 1450.

Imagine how much money the government is collecting income tax due to this slab system.

So, if the government has data regarding mean income of each tax slab, and if income is indexed, this example shows government can create the necessary amount of inflation so as to push them to the next tax slab where they have to pay tax. In this way government can collect revenue.

But does it make sense for the government given that people dislike inflation and government will earn a public ire? If the mean income in the tax slab is close to the upper boarder (that is, close to 3L in the exempted tax slab), then government may go for it. If the average income is much lower than the upper boarder, then it has no incentive to create more inflation so as to push the tax payers to the next tax slab. But here’s is the catch. If government is seriously considering generating revenue through this way, then it can redesign the tax slab very close to the average income in each tax slab. For example, in the first category which is exempted, the mean income is, say, 2.4L. So, the government can redesign the tax slab in the budget from 0-2.5L. Then with little effort it can push the inflation.

Monetary Policy is Not Irrelevant

In this piece Surjit Bhalla of Indian Express bashes monetary policy and claims that he has found the panacea to kill inflation. The blurb of yesterday’s piece is that it is the MSP, the stupid. If you want to control inflation either reduce it or freeze it. And if you can’t then reduce interest rate. It will unleash the animal spirit of the Indian entrepreneurs. Indian growth story, he claims, will soon resume its pace. Much of Mr Bhalla’s claims are does not stand the scrutiny.

He begins his piece by saying that he is pleased to see CPI-inflation at 7.8%. Maybe, it is comforting for a man like him who gets a six-digit pay check. But he does not give this credit to RBI. He is of the view that RBI’s epic battle (by hiking the repo rate) since March 2010 has done little to control inflation, which is true. Both inflation and inflation expectation (a quarterly survey conducted by RBI) is very high, much beyond RBI’s comfortable level. But Bhalla gives credit to RBI’s clear communications: that it will keep repo rate high till inflation cools down, the talk of inflation targeting, anchoring inflation expectations. I will come back to this bit later.

Then Mr Bhalla claims it is sheer nonsense to explain Indian inflation by using stuffs like money supply, credit growth, and fiscal deficit. Econometrics investigation, he argues, offers zero explanation of Indian inflation.

Then one fine morning he invents a model that can solve age-old problem of inflation in India. How was he able come with this earth-shattering idea? He found the bad guy – minimum support price (MSP). He trusts his model so much that he challenges (oh yeah, it’s a friendly challenge!) RBI and other inflation-concerned people to prove him wrong. It succeeded intimidating me.

Unless we see his research paper we can’t comment his model. Unfortunately, downloading that paper was not possible. We don’t know if variables are subjected to unit root test (to test whether they are stationary). My first gut reaction after seeing his model how can one explain Indian Inflation – so complex – by using only one independent variable? I thought two-variable model exists in the intro econometrics textbooks to teach students in the classroom. No, i was wrong. It seems Mr Bhalla has taken it seriously, so seriously that he recommends his policy advice to GoI on the basis of his toy model.

Okay, let’s verify his claim that MSP is the stupid. He says MSP is rising because of political reasons. He can't be be ignorant of cost factors. MSP is rising because input cost is rising (see Chat 7 of Rajan’s speech). Cost is rising because government is setting administered prices free and rural wage (see Chat 8) driven by NREGA. Despite rising MSP, the terms of trade of output price to input price remains more or less same (See Rajan’s speech).  fact, the MSP provided by the GoI is comparatively much lower than what other countries provide.

But nobody downplays the role of MSP and the behind-scene politics. MSP growth is correlated with inflation. If we want the right MSP, then CACP should be empowered, given full autonomy and its recommendations must be mandatory. Institutional reform is necessary for CACP, FCI.

But saying that MSP is entirely behind the inflation is ridiculous. A simple way to verify his claim is to check what has happened to the price of non-MSP food crops. In fact, Ashok Gulati, former chairman of CACP argues that prices of non-MSP goods have risen more than MSP goods. If this is true, how logical is to argue that it’s the MSP, the stupid?

In his attempt to provide the earth-shattering model he loses sight of other factors that are also largely responsible. In my view, the elephant in the room is the distribution of foodgrains (see Kausik Basu’s paper).

Now assume that his model is a fine. So what does he recommend? Surprisingly, he did not say anything about MSP. You would expect him to recommend: either to freeze MSP or reduce it. But he recommends cutting repo rate. Since it does not stem from his model i guess it comes from his frustration to see RBI not paying heed to the Indian Express columns! (Just kidding). I guess he recognised the fact that is politically difficult to freeze MSP; so he did not say anything about what to do with MSP.

I have never seen anybody giving recommendations beyond what his model says. In his model, interest rate does not exist. How can he claim that interest rate does not matter for inflation? Further, if he believes that interest rate is holding investment, then he should show it. He should run a model regressing investment or growth on interest rate.

Now think of freezing MSP and assume that it is politically possible. Given that farmers are habituated to MSP growth every year they may react sharply by reducing production which will be double whammy. How much production will decline depends on the elasticity of production with respect to MSP. Freezing is good idea. But in the short run production will fall as a result of freezing and thus, price will rise. However, it is good in the long-run. So, this is not the right time to freeze given that input cost is also rising due to freeing up of administered prices.

Since he is bashing monetary policy because of high interest rates, it makes sense to ask: what is holding back the India Inc? High interest rate, stagnant global economy, economic uncertainty (govt’s policy mess/lack of clarity), corruption or agricultural stagnation?

He seems to believe that if we reduce interest rates then economy will bounce back. But he forgets that repo rate hike affects only 0.5 per cent of the entire borrowing of the banking system. Stated otherwise, it is not a constraint to credit supply and liquidity. This is a very important point which has been missed in the debate and discussion on monetary policy since Governor Subbarao was habituated with raising interest rates.

High interest rates are not a major problem that the India Inc is facing, rather the messy (now it is changing) domestic policy atmosphere that drags the India Inc. Rajan and his predecessor has ensured that liquidity is not a problem. And i also think that liquidity is not a problem. If Bhalla is very concerned about falling GDP figures, then he should pray that Modi government rolls out the much needed reforms almost in all sectors. I can bet that FDI and domestic investment will flow like flood. High interest rate sometimes lead to high investment. Yes, you hear it right. Mr Raj Chetty - a Harvard Professor, who won last year’s JBC medal – has shown it. His mentor Feldstein was convinced. Then why is investment low in India? I think Baker, Bloom, and Davis provides us the clue. It’s not the interest rate, the stupid, rather the economic uncertainty (foggy policy). A large literature has spawned off following the works of Baker, Bloom, and Davis (see India’s policy uncertainty index, it is very high as of August 2014) showing how high policy uncertainty leads to reduction in investment.

Sure, Rajan  can’t claim much credit for falling of inflation figures. It may be sheer luck. But today’s monetary policy (New Keynesian models) works on how well a central bankers communicates with public, expectation management, commitment to any monetary policy rules. It may be Prime Minister Modi too. People know Rajan means business. He talks tough on inflation and also he walks the talk. But then media reports said that Rajan might lose his job if Mr Modi comes to power. But this did not happen. Mr Modi reposed faith in Rajan. This sends a clear, loud, very strong message to the market that both are serious to kill inflation, the bad guy. This might have led public’s slowly-declining inflation expectation.

It raises question why RBI has so far not succeeded in bringing down inflation? RBI’s baby step approach (hiking repo by 25 basis points) is criticised by economists. That makes it always behind the curve. In my blog post i argued RBI should have gone for big hikes in repo rate if it was serious as Mr Subbarao lamented later.

So, where should we go from here? The declining numbers may give cheer to central bankers. But i think they can’t allow the situation go out of control. They should not reduce interest rate; rather keep it high where it is now. If they reduce it and if Inflation rises then both Mr Rajan and Mr Modi will lose credibility. Public will view that the duo have accepted defeat against the Inflation Goliath. This thinking has serious repercussion on future monetary policy and its success. It will jeopardise their credibility, inflation targeting will lose all its charm (i don’t endorse India to adopt inflation targeting. The time is NOT ripe now. However, we may try with some loose form of IT). People may lose faith in monetary policy.

More importantly, we have enough research showing that when headline inflation stays high for a lengthy period, it is highly dangerous for the economy for two reasons. First, it will lead to permanently high inflation expectations. Second, high headline inflation or food inflation is translated in to high non-food or core inflation via high and sticky inflation expectation (see Walsh, Prachi Mishra).

Indian inflation is so complex that any careful student of inflation would adopt a balanced view: it is due to demand factors like money supply, fiscal deficit, NREGA expenditure, shifting dietary pattern (due to rising rural wage?); and supply side issues like MSP, distribution of foodgrains, poor monsoon (resulting agricultural falling output), international raw material prices, global prices of oil products and foodgrains. And yes, exchange rate is also important. He seems to discredit all those factors.

Since, RBI has been fighting an epic battle it must win at any cost. It can’t let the situation slip from its control at this time where victory seems visible. Let us hope that RBI wins this epic battle as soon as possible. 

Update
I found this IMF article by Rahul and Tulin which says  heightened policy uncertainty and deteriorating business confidence have played a key role in the recent investment slowdown.  This is basically what my blog post is arguing. (read here the blog post by the authors)

What should we tax: Nominal or Real Income?

The base of income tax all over the world is nominal income that you earned in the previous financial year. Although, it is plain and simple to collect tax on nominal income yet it has serious limitations. Suppose your monetary (nominal) income remains same but you witnessed inflation rising from 5% to 10%. Three types of response can happen. One, your income may raise fully to compensate the rise in inflation (this is your real income remains fixed); two, you may see partial compensation of monetary income; finally, you may see no upward adjustment of your income. In this case you suffered income erosion due to high inflation. Further, consider when inflation is high and variable and uncertain nobody can perfectly predict the future income. That means you are bound see your income deprecating due to high inflation. The pain does not end here!

But does the income tax recognize the pain that you suffered from real income erosion due to high inflation? Sorry, no. It does not care what your real income is. It is interested to see what your monetary income is. It adds salt to your wounded area.

So, you see inflation leads to a double-loss of your real income. First, inflation does not bring an upward revision of your income. Second, you are taxed on your nominal income. A simple example is given to help you better understand this point. Suppose your income is 2 lakhs per annum. Tax exemption limit is Rs 1 lakh. That means taxable income is Rs 1 lakhs. Now bring inflation into discussion. Say, inflation is 10%. That is WPI has moved from 100 to 110. But your nominal income has not increased. So you suffered your first loss. You receive the second loss when you pay income tax. Tax rate is 10%. That means you have to pay Rs 10,000 to the tax department as your income tax. Real income is nominal income divided by inflation rate. Real income is (Rs 100000/110)*100 = Rs 90909. Income tax is Rs 90909*0.1 = 9091. So you save: Rs 10000 (which you have to pay when taxation is based on your nominal income) - Rs 90909 (which you have to pay when taxation is based on your real income) = Rs 909. This says if you are taxed on nominal income then you are paying Rs 909 more to income tax department. If your income remains same and inflation continues to rise at 10% per annum, in 5 years you can save: Rs 909*5 = Rs 4545. Not a small sum that you can choose to neglect!

So, i think is better to tax income not on the basis of what your monetary income is, rather what your real income is. The benefits are huge. Government has no other option than to rein in inflation. As a result, citizens will less bother about inflation. Governments have paid huge price for not controlling inflation. The recently concluded general election provided fresh evidence to it. 

A Comment on the Climate Change Report

Summer has become hotter and longer while that of winter has declined. The effects of climate change across the globe are asymmetric.

How do people react to the new IPCC report, released on March 31? Well, the important question is how rich countries have reacted to it. They will shrug and say ‘look, we have technology; we can handle the looming disaster’. First, they will be suspicious of the report. And complain that it is controversial. They will say the methodology and assumptions are not correct and al that blah blah. It has been, they go on complaining, written in such a manner that it demands rich countries to do more on reducing factors that cause climate change. Then they say we can devolve technology and we don’t have to sacrifice growth. Because in their dictionary the word “sacrifice” does not exist. These are classic cases of what you call fool. A natural disaster, unlike man-made disaster (like riots and all that) does not differentiate between rich or poor; or whether you are from the US or Bangladesh! All will be equally impacted. No question of inequality here! That is zero Gini coefficient! Yet they think that they can overcome these devastations. What a cruel joke? They also make nonsense arguments like the cost of taking climate change reducing actions far outweigh the benefits. Hence, it is best to do nothing and become witness to this devastation. Then they propose some smart concepts like carbon trading system which is unethical. This is unethical because rich countries don’t want to sacrifice growth. They have money and they can buy pollution from poor countries. In return poor countries have to reduce carbon dioxide and other GHGs. Since their manufacturing is primarily based on traditional technologies they have to sacrifice growth. This is the essence of all these smart concepts that those rich countries have innovated. It is high time that we acted now. It’s a question of now or never.

For god’s sake don’t get me wrong. I did not say that all actions have to be undertaken by rich countries. Poor countries must act. But when I see poor countries they say we can’t sacrifice growth. Hence we will reduce less GHGs and all that. They blame rich countries. And rich countries blame, though rationally, poor countries like India and China. For heaven’s sake stop this blame game and ACT NOW.

It is crucial to ask how youth react to such reports. Well, most are unaware and uninformed about the effects of climate change. And what about the educated youth? They hardly bother to care about it. They say: look, we have money. We can buy ACs, AC-cars and all that. They behave like rich countries. They are careless in using water, electricity, polluting air. Nothing can be sadder than this appalling attitude of youths upon whom the future of globe rests on.

How to Create More Inflation?

American economy has been struggling to recover from the Great Recession of 2008. Economists, policy makers, political leaders of the US have tried their best to end this recession as soon as possible. The US resorted to humongous fiscal spending, unconventional monetary policy. Yet, it is far behind its pre-crisis level when it comes to major economic indicators. To help recover the economy, New Keynesians, on the other hand, suggested higher inflation can do this job. The logic is simple: consumers would find spending now is prudent. People buy more and companies accelerate investments when things cost less today than tomorrow. Another benefit is that it makes your debt payments easier. So, how can we create more inflation? Well, some economists say the central bank should announce that it wants higher inflation. This announcement if perceived credible by public, they argue, is enough to take the economy to a higher inflation regime. And if does not, then central bank should be ready to act, that is, loosely speaking by printing more money. The Fed should go for an expansionary policy sufficient to raise the inflation that the Fed wants.

Yet, some argue engineering inflation by the Fed is not as easy as its advocates argue. Well, issues like political differences between Democrats and Republicans, credibility, time inconsistency, and reputation come into picture that makes the matter worse. For example, if inflation slips from the Fed’s control, then it has to create another recession to end higher inflation.

If we want more inflation raising the minimum wage, I think, will do that. So, if higher wage gets reflected in higher prices (in fact, it has some evidence), Keynesians argue, would lead to a rise in demand. And this brings cheer to New Keynesians since they argue that inflation can serve as a panacea to a zero-bound constrained economy.

But then why raise the minimum wage and distort the labour market? You will be tempted to think it may result in higher unemployment. The arguments for raising minimum wage are (a) minimum wage in the US has been kept on freeze since July 2009 (b) raising minimum-wage would provide a much-needed boost to the earnings of low-wage workers; that is it would raise standard of living and further, it would have a spillover impact on workers whose wages are just above the new minimum, (c) thus it would reduce poverty, (d) inequality has been sharply increasing and (e), wage has been slowly falling, though latest data suggest it is slowly rising. It might also lead to rise in productivity.

Okay. But what about its impact on unemployment? A large chunk of the research carried out by economists showed that it has zero or negligible impact on the employment of minimum-wage workers. But one thing that is missing in the current debate on minimum wage is that it might lead firms to substitute labor by capital.

Those who oppose this move argue that raising minimum wage is not a ‘panacea’ that can fix the economy. They argue rise in labor costs would cost employment. That is, firms would remove some of their workforce. I think they don’t take into account of employment addition due to rise in demand coming from hiked minimum wage. Further, they argue that increased wage would be visible in higher product prices. Another point they raise is that higher minimum wage would not substantially help the poor since many low-wage workers are not members of low-income families.

But i have two objections to the arguments made by the proponents of raising minimum wage: First, if wage is falling then we should see more jobs being created and recovery of the economy.  After all, Keynes said in 1936 that markets could not clear because wage (and price) was sticky. According to Keynesian camp, this was the major cause of protracted depression. So, falling wage is good sign that Keynesian devotees should cheer about. Second, what guarantee is there that hiked minimum wage would propel wage earners to spend more given that uncertainty remains high? They might choose to save if they are rational and far-sighted. We have evidence that they saved a lot from transfer payments.

Fair enough. So we learned from both these camps is this: a higher minimum wage will lead to increased money income in the hand of low-wage earners. So they would spend more. Further, firms would raise their prices to offset higher cost of labor. At the same time, firms might reduce hiring of labor and in fact reduce workforce. However, the balance of evidence suggests that rise in minimum wage have had negligible or no negative effect on the employment.

So, we have three benefits: inflation-induced higher demand, higher minimum wage-induced higher demand and rise in productivity; and one cost: rise in cost of labor. The biggest benefit is that no citizens will oppose it. That means tacitly they are favouring a higher inflation. Citizens will never allow raising inflation even if it is best for the economy and consumers. Hence minimum wage increase is the easiest solution to engineer inflation.

Dear High Inflation, Rest in Hell.

Prof. Srinivasan’s monetarist history lesson tells us that to control inflation either tax rate should be hiked or monetary tightening, or both. He is asking Indian authorities to do what British did in early eighties. Though his prescriptions seem weird, yet this is exactly the Government of India (GoI) should do now. Although the chance is very less that the government of the day would pursue such vote-killing policies, yet this will benefit the country for sure. Why such tough prescription? Though we both have the same prescription, yet my reason is bit different from Srinivasan’s.

First, i discuss why this prescription looks weird and then tell why this serves better the economy.

1.      We need to ask what kind of inflation Britain reduced: demand (originated) inflation or supply (originated) inflation? To counter supply-shock in the 1970s Britain used monetary and fiscal policy to stimulate economy. Hence, disinflationary policies worked.

2.      Srinivasan seems to attribute this inflation to excess demand. A measure of excess demand is “core inflation”. It is the non-fuel non-food inflation and is almost in control.  Food inflation is the biggest contributing factor to high inflation.

3.      How can we control supply inflation with a monetary tightening? We know monetary policy can cool down only core inflation. Optimal monetary policy should stabilize the inflation in sticky prices, so central banks should not try to counteract commodity price inflation or deflation.

4.      If he is prescribing for either a tax hike or severe monetary tightening, then the economy may go to hell again. We know that both the Euro area and the US are not out of woods yet. In fact, in a recent IMF speech by former US Treasury Secretary Larry Summers, endorsed by Krugman, predict that the US economy may be slipping into a “secular stagnation”. If that is the case, then our exports demand would remain weak for long time. In this case, it is not right to step up the monetary brake now.

5.      What is holding back India growth story: high inflation or governance pause on reforms, or depressed advance economies? To be fair, each accounts for one-third of the slowdown.

6.      Prof. Srinivasan says deficits crowds out productivity-enhancing private investment. Of course, it is true. But we need to ask by how much. It is the reforms and scams that has choked investment sector. Availability of credit is indeed a factor. But this is not a big factor compared to government inaction. We should not also forget that in this period government inaction forced India Inc to go abroad. Indian industrialists Ratan Tata, Kumar Mangalam Birla, Anand Mahindra spoke to media venting out their anger on government. Deepak Parekh puts it nicely “Earlier, investing abroad seemed to be a risk diversification but the current impasse (in governance) makes it a necessity for companies to look elsewhere,"

To put it in one sentence, RBI’s fighting has not been successful and that is because the government is not cooperating. The question that automatically follows is how logical is this to argue that RBI should step up its effort to rein in inflation.

In the present circumstances it is a fair assumption that growth is going to remain sluggish throughout the next year. What shape the economy will have next year depends upon the General election to be held next year. If a clear mandate comes, it may help the policy making faster and investors would gain confidence and investment would rebound. But if we get a fractured mandate economic uncertainty will rise, thereby negatively affecting key macroeconomic variables. And given coalition politics and exit polls, it seems that we may be heading for a not-clear mandate.

The recent loss of Congress party in all the four assembly elections heightens this uncertainty. One impact of this loss is that the reforms in the Parliament would be stalled till the next Central government is formed. Investors fear that bills passed by this government may be overturned by the next government. So, a rational businessman would prefer to wait and watch.

Both inflation and inflationary expectation have been sticky due to both RBI’s “Boiling Frog Syndrome” approach and GoI’s spending binge. We also know that success of monetary policy is contingent upon fiscal policy. So, both should go hand in hand to achieve inflation reduction objective. While the GoI is shedding crocodile tears for high inflation, RBI has been fighting a lone battle since March 2010, without much success. As of now GoI has spent 84% of expenditure sanctioned in the Parliament and that too without accounting for fuel subsidies! It suggests that GoI is less serious in containing inflation.

Further, it is an election year. And the recent loss may prompt the central government to go for more vote-wooing sops and freebies which implies more expenditure. So, the government might be tempted to spend more. Given that we can’t have a US-style drama of “government shutdown” fiscal deficit is bound to exceed its target in this fiscal. Neither a huge cut in the expenditure is possible, as Finance Minister Chidambaram assures us nor a up in the tax rate is possible. These factors translate into higher inflationary expectations, and thus, higher inflation. This will surely jeopardise RBI’s efforts to bring down inflation to moderate levels.

So from the above discussion we find that four things warrant for such a tough action. They are: (1) domestic slowdown will persist for at least one year, (2) central government has spent 84% of its expenditure sanctioned for this fiscal, (3) this year being an election year, central government might be tempted to spend more, and finally the advanced economies will be weak for at least one year.

But the question is how to kill inflation and its cousin inflation expectation. So far RBI is not successful in its war against inflation. Former RBI governor Subbarao admitted that it was this “baby-step approach” of the RBI that failed to control inflation. So, RBI should tell the government clearly and loudly that it is serious to bring down inflation and it would keep the interest rate heightened until central government pursues prudent fiscal policy. More importantly, if it wants to get victory against inflation it needs to abandon its “piece-meal approach” of hiking repo rate by 25 basis points each time. That means RBI can go for an all-out attack on inflation; it needs to hike interest rate sharply. Rajan has been less tough on inflation than he speaks. And if he continues to follow his predecessor’s legacy, it would land the Indian economy no where: neither inflation will cool down nor growth will peak up.

However, the reality, as emphasized by Srinivasan is that monetary policy is going to be of little help unless and until fiscal policy shows discipline. But fiscal indiscipline is the order of the day. This is why i am less confident that rise in interest rate will reduce retail inflation. Yet it is worth trying, given that growth is going to remain sluggish. Hence, pursuing such anti-inflationary policies would ensure minimal output loss (that is, a small sacrifice ratio). Hence, this is the best time to reduce inflation.