Inflation,investmentandgrowththeroleofmacroeconomic.pdf

4 Inflation, investment and growth: the role of macroeconomic policy in India Ila Patnaik and D.K. Joshi1 This chapter examines the relationship between growth and inflation in the long-run. Although positive in the short-run, cross-country studies indicate a negative relationship between the two in the longer run. There is now considerable evidence to show that investment is one of the most important determinants of the long-run rate of growth. Recent developments in the theory of investment behaviour have focused on the role of instability and uncertainty in determining investment. Inflation as an indicator of macroeconomic instability is hypothesised to have an adverse impact on investment and hence on growth. Our estimates of the private investment function in the manufacturing sector support this hypothesis. The private investment function for agriculture points towards the role of public investment and credit in encouraging private investment in this sector. Tradeoffs between inflation and growth that emerge in the medium run, as a result of government policies relating to consumption and investment, are also examined using an economy-wide econometric model. The analysis suggests that higher growth can be achieved by controlling inflation and increasing public investment. Inflation, investment and growth: the role of macroeconomic policy in India We will examine the relationship between growth and inflation in India. In the short run, the relationship between growth and inflation is usually positive. Policies that raise output (for example, expansionary fiscal and monetary policies) also raise prices. Inflation is undesirable because it adversely affects some sections of the population (especially the poor and those whose earnings are not indexed to prices), distorts relative prices, leads to an appreciation of real exchange rates, erodes the value of the financial assets and creates instability. The ultimate policy objective is a higher level of well-b