Sectoral effects of disinflation: Evidence from India

Abstract

This paper makes an attempt to measure sacrifice ratios for the farm and non-farm sector as disinflation policy is believed to have differential impact on these sectors. Using the non-parametric approach of Ball (1994), five disinflation episodes are identified for India over the period from 1950–51 to 2009–10. These disinflations are largely due to contractionary monetary policy pursued by the Reserve Bank of India. The estimates of the sacrifice ratio and the presence of persistence and hysteresis effects indicate that disinflationary monetary policy is more harmful to output growth in the non-farm sector. In contrast, the negative sacrifice ratio in the farm sector implies that there is output gain during disinflationary periods. This output gain in the farm sector seems to have been driven by those factors which are independent of contractionary monetary shocks. These evidences also suggest that use of aggregate time series data might produce errors in the measurement of sacrifice ratios.

Keywords:

• sacrifice ratio
• disinflation monetary policy
• persistence
• hysteresis

JEL Classification:

• E52
• E58

Notes

1. Subsequently the literature on sacrifice ratio found evidences on how the magnitude of output loss depends on the rapidity of disinflation and rigidity of nominal wages and prices. The disinflation process tends to be less expensive when it happens at a slow pace so that wages and prices have time to adjust. In contrast, output loss tends to be much higher when the course of disinflation is quicker and the nominal rigidities are also much stronger. However, Sargent (1983) argues that quick disinflation known as 'cold turkey' is inexpensive as expectations adjust much faster.

2. See Doll (1958), Barnett, Bessler and Thompson (1983), Saunders (1988), Isaac and Rapach (1997), Hayo and Uhlenbrock (1999), Carlino and Defina (1998), Arnold and Vrugt (2002), Raddatz and Riggobon (2003), and Ibrahim (2005).

3. Although the heterogeneous impact of monetary policy on various sectors in India is yet to be established, Nachane, Ray and Ghosh (2002) show that states with larger financial deepening and concentration of manufacturing sector are highly sensitive to monetary policy. The major policy implication is that states with a larger proportion of their domestic product originating from primary sectors would remain relatively insensitive to monetary policy.

4. Altogether seven disinflation episodes are identified, but according to Ball (1994) a minimum decline in annual inflation rate of 2% for quarterly data and 1.5% for annual data is required to confirm that there is disinflation. We report only five episodes as the two disinflation episodes identified in last decade are not qualified by Ball's criterion.

5. Ball (1994) has argued that using conventional methods such as the Hodrick-Prescott filter to obtain potential output is inappropriate, as it would undermine the true measure of potential output during recession. See Bordoloi, Das and Ramesh Jangili (2009) for a comparison of different methods to estimate potential output in India.

6. However, the use of annual data is likely to undermine the estimates of the sacrifice ratio because time aggregation smoothens the output series (Ball 1994). Unfortunately, reliable quarterly data on GDP for the time period prior to 1996 is not available for India. Nevertheless, we make an attempt to measure the sacrifice ratio using seasonally adjusted quarterly GDP data available from the first quarter of 1996–97. The identified disinflation episodes have failed to fulfil the criterion set out by Ball (1994) to qualify as a disinflation episode.