The rational expectations school opposed the nonneutrality position by arguing that, under flexible markets, repeated monetary shocks given to facilitate growth could only result in recurrent price rise in the long run. The evidence of an inverse relationship between inflation and growth further demolished the role of price incentive in stimulating growth. Decomposing inflation into two components – core and non-core-the former may be interpreted as the underlying trend of inflation after eliminating temporary price changes caused by supply interruptions or erratic market behaviour.

Literature identifies core inflation as that which is capable of affecting the real output in the short term only and not in the long run. Thus, it coincides with the vertical long-run Phillips curve. Shocks have been categorized into two kinds: core inflationary disturbances and non-core disturbances. The core inflation disturbances are medium- and long-term output-neutral while the non-core disturbances are transitory shocks which propagate to inflation but have no substantial and persistent impact on inflation. This allows for making meaningful distinction between different inflation components based on their effects on the macro-economy.

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The identification of core inflation as the inflation to which economic agents adjust without affecting output or employment in the long run is important from the point of view of assessing the effectiveness of monetary policy. If money supply changes and price changes do not affect the real variables like output and employment in the long run, monetary policy will be treated as ineffective. So in the vector auto-regression framework, the rate of growth in prices which is related only to its past magnitudes can be considered as core inflation. If we consider the period 1983 to 2000, the core inflation (based on the WPI of all products) turns out to be 6.54 per cent per year compared to the actual/observed inflation of 7.8 per cent per annum.

This means that core inflation accounted for almost 84 per cent of the total price rise. In other words, a large component of the price rise was non-beneficial: it did not provide any stimulant to the producers to augment production. Over the period 2001 to 2011 the actual inflation was 5.78 per cent per annum while the average core inflation was 5.51 per cent per year, nearly 95 per cent of the price rise was futile with no impact on the real variables. As we come to the third period, comprising 2012 through 2023, a turning point is observed. The actual inflation rate of 3.12 per cent per annum is lower than the core inflation rate of 4.47 per cent per annum.

In other words, with no government intervention, prices which cannot influence the real variables positively by incentivising the economic agents, would have increased at a rate higher than the actual price increase during this period. The success of the Modi government can be envisaged in two distinct ways. First, it reduced the core or non-beneficial inflation from around 6 per cent and 5.5 per cent per annum as witnessed in the previous regimes to about 4.5 per cent per annum. Secondly, without the role of the government, prices would have shot up at a rate higher than what was actually observed. Reducing the actual inflation to an all-time low rate of only 3.12 per cent which is even lower than the core inflation rate of 4.47 per cent unfolds massive success of the government in managing the economy.

If we consider the period 2014- 2023 the core inflation and the actual inflation rate turns out to be 4.57 per cent and 3.80 per cent per annum respectively. Notwithstanding the external shocks led by the pandemic the price management could actually be carried out fruitfully. The significant decline in consumption poverty during this regime can also be rationalised in the backdrop of this efficiency in price supervision. (The writer is Professor, South Asian University.)