Here's what the government must do to tackle inflation Bhaskar Dutta Warwick: I wrote in this column a couple of months ago that the rate of inflation had just crossed 7 per cent, and went on to add that this was the highest price rise witnessed in the previous 40 months. There was an air of acute despair amongst top Congress leaders since no easy options seemed to be available to the government to control the surge in prices of a wide range of commodities, including most unfortunately staple food items. Today, the prime minister and his senior cabinet colleagues would probably be very happy to give up their salaries for a month or two if they could turn the clock back to April! The rate of inflation has now touched a mind-boggling 11 per cent. And what is worse is that the future looks just as bleak as it was in April. No one can predict when the process of spiralling prices will come to an end. As readers of this newspaper surely know, the current inflationary process is a global phenomenon and practically every country is suffering. To get some perspective on the worldwide experience, consider these figures. The Goldman Sachs index of commodity prices has doubled since early 2007. Nominal prices of oil have increased by 150 per cent over the same period. Very simply put, the world economy is just not producing enough to satisfy rising world demands. Some time ago, President George Bush earned instant notoriety because he quite naively (but why expect anything else from him?) blamed China and India for the rise in food prices. However, there is a grain of truth in his statement. Emerging and developing countries have been growing significantly faster than the rest of the world, and there has been a steep surge in demand in these countries. This has been a major cause for the rise in world demand because the economies in most developed countries have been stagnating. Since there is no reason to believe that world production will rise miraculously at least in the immediate future, many people expect that prices will keep on rising. These expectations in turn exacerbate the inflationary process. Households buy more of non-perishable goods than they need for their immediate consumption because they expect prices to go up even further. What is worse is that traders withhold stocks from the market in the hope of being able to sell these at higher prices later on. In other words, expectations of higher prices become self-fulfilling. What can the government do under these circumstances? In the short run, it is not easy to increase domestic supply. So, its policies must be aimed at reducing aggregate demand. Of course, attempts to restrict demand will obviously have some adverse consequences for growth. The inflation-growth trade-off is perhaps the single most important factor causing sleepless nights to central bank governors and finance ministers. Which should get priority? There is no magic cure-all solution for all times and all economies. But when inflation rages at close to double digit figures, clearly the only sensible solution is to lower the targets for aggregate growth at least in the short run, and pursue appropriate monetary policies. At such times, the credit policy becomes particularly crucial. The Reserve Bank has to raise interest rates and perhaps also put quantitative restrictions on the supply of credit. These measures dampen overall aggregate demand in the economy by increasing the cost of borrowing. Moreover, a higher cost of borrowing also discourages hoarding since the cost of maintaining stocks also goes up. While contractionary monetary policies will have some effect on the general level of prices, more needs to be done in order to reduce food prices. Unfortunately, there are no easy options, partly because of the past sins of the government. There was a time not so long ago when our buffer stock was so large that it was an embarrassment of riches