Inflation, investment and growth: the role of macroeconomic policy in India

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.