Different way of measuring Inflation

As you people may be aware that this week's inflation came down to 0.18% even though basic food article's price is moving north direction due to high base effect. Many times I have written about drawbacks of Our Inflation Measurement System.

In today's mint there is an article by Mr. B Y KAUSHIK DAS about new way of measuring Inflation. I am posting some excerpts from that article.



The Austrians define inflation as the aggregate expansion of total money and credit. This definition has no mention of purchasing power or prices. Mainstream economists define inflation as the rate of increase in the general level of prices of goods and services.

The true cause of inflation is always excess money supply or credit relative to the real pool of savings present in the economy.

Moreover, trying to capture inflation through simple price indices can throw up a completely misleading picture about the financial stability of an economy. For example, if the excess money supply had found its way into stock markets or in the real estate sector, price indices such as CPI and WPI will not reflect such a bubble as asset prices do not form a part of CPI or WPI.

An Austrian economist who considers inflation only as a monetary phenomenon will focus his attention on broad money supply (M3) growth to get a gauge of the true inflation prevailing in the economy. For example, if RBI expects the Real GDP to grow at 7% in fiscal 2009 and expects average WPI inflation to be 9.2% for the whole year, then the M3 growth target should be 19% (7X1.4+9.2) for fiscal 2009.

In the current down cycle, however, aggressive monetary and fiscal stimuli have been administered (and more likely to come) since October to prevent the economic growth from free falling. The stimuli have resulted in M3 growth remaining at high levels of 18-19%, while economic growth has continued on its downward trajectory. The government’s huge borrowing programme on account of the various fiscal stimuli in fiscal 2009 and fiscal 2010 has already led to severe strains on bond market yields, hampering the effective transmission of monetary policy measures adopted so far. In order to relieve the strain on bond markets, some market participants are, therefore, suggesting a direct monetization of the fiscal deficit as the last resort over and above the back-door monetization of defi cits that is already in vogue in the disguise of open market purchases of government bonds. If this were to happen, the money supply growth would continue to remain high or may even increase as monetizing deficits are same as printing money.