Growth-inflation trade-off - Empirical estimation of threshold rate of inflation for India

The empirical analysis of growth-inflation trade-off has received keen attention in macro-economic research in the recent years. Even as it is generally argued that inflation is not good for growth, some investigators have pointed out that the negative effect is pronounced and serious only in inflation breaches its specific threshold rate for a country in question. This paper makes an exploratory attempt at empirically estimating such a specific threshold inflation rate for India by following the methodology due to Sarel (1997). With a sample covering a period from 1981-82 to 1995-96, it is estimated that an inflation rate of more than a threshold rate of 6 per cent per annum would have a significant downward impact on growth in India as against Sarel's common estimate of a higher threshold of 8 per cent for a large pooled sample of 87 countries including India and covering a period from 1970 to 1990. In particular, our empirical results indicate that, on an average, a single percentage point increase in the inflation rate above the threshold rate of 6 per cent per annum harms economic growth in India by about half a percentage point per annum. It is also demonstrated that the estimated threshold inflation rate is robust and invariant to changing sample periods including the pre- and post-liberalisation phases.