Infltion and Its Impact on Monetary Policy

MONETARY POLICY AND

V INFLATION

5.1 It is now widely agreed that monetary policy

can contribute to sustainable growth by maintaining

price stability. Price stability, in turn, may be defined

as a rate of inflation that is sufficiently low that

households and businesses do not have to take it

into account in making everyday decisions. High

inflation has an adverse effect on growth due to a

number of factors: distortion of relative prices which

lowers economic efficiency; redistribution of wealth

between debtors and creditors; aversion to long-term

contracts and excessive resources are devoted to

hedging inflation risks. In developing economies, in

particular, an additional cost of high inflation

emanates from its adverse effects on the poor

population. Maintenance of low and stable inflation

has thus emerged as a key objective of monetary

policy and a noteworthy development during the

1980s and the 1990s was the reduction in inflation

across a number of countries, irrespective of their

stages of development. This reduction in inflation is

believed to be on account of improvements in the

conduct of monetary policy, although there is an

ongoing debate on this in view of other factors such

as globalisation, deregulation, competition and

prudent fiscal policies that might have also played a

role. In advanced economies, inflation rates in the

recent decade have averaged around 2-3 per cent

per annum - consistent with the establishment of

reasonable price stability. In developing and

emerging economies too, inflation rates have

declined significantly.

5.2 The current phase of low global inflation is

comparable with the pre-World War II phenomenon

when inflation rates across regions were quite low.

In the post-World War-II period, however, price levels

showed a clear upward trend, with inflation rates

rather than price levels clustering around a stationary

level following price shocks. In particular, the collapse

of the Bretton Woods...