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Inflation has irritated most central bankers. For the last two years, the US Federal Reserve has been persistently gunning at inflation and finally paused when the interest rate crawled up to 5.25 per cent. It is now the turn of the European Central Bank (ECB). Earlier this month, the Bank increased the rate of interest by 0.25 percentage points to 3.75 per cent. Even then the ECB president signaled that the increase was not the last, leaving the market to guess when the next jump would come. Japan is the only country that would prefer a little bit of inflation to fire its economy.

In most major countries inflation has been below 3 per cent, the exceptions being Russia, India, Indonesia, Venezuela and Argentina. Generally, in developed countries inflation has been lower than in developing countries because the latter cannot afford to compromise on growth. The more advanced countries like US, UK, EU, or Australia strive to maintain inflation below 2 per cent.

It may appear that the ECB has been super sensitive to inflation. Although it has set its inflation target at 2 per cent, it reacted even when inflation was only 1.8 per cent. It is the possibility of inflation that has inspired the bank to take preemptive action. One of the critical parameter is money supply (M3). It rose 9.8 per cent, fastest in 17 years. The intention is to prevent inflation rather than fight it later.

Interest rate hikes did not impact well either in the US or in the EU. In the US, the rate of growth hardly dropped; in the EU the seven increases in interest rates in the last 15 months kept growth in tact at 2.6 per cent. That is no wonder because, first, the difference between interest rate and inflation rate has to be significant to make an impact; second, the impact cannot be expected to come with certainty; and third, there is always a time lag for the impact to be visible. It is only now that the increase in interest rate by the Federal Reserve has begun to bite and that too in the housing sector. There are apprehensions, however, that the economy may run into recession by the end of the year if the interest rate is not lowered.

The Reserve Bank of India has also been quite sensitive to inflation and raised the repo and reverse repo rates along with CRR in the latter part of 2006 to restrain credit and raise its cost. Perhaps, RBI could have acted a year earlier when there were signals that inflation was on the way since money supply had been increasing at more than 18 per cent per year. Had the rate of interest been increased at that time demand management would have been easier and more effective. Nevertheless, RBI should be in no hurry to hike interest rates further since, as in the US, it may result in over-kill. With the measures already taken inflation should substantially ease in the next few months.

Email: rpgfoundation2000@yahoo.com