Inflation may be lower but unemployment has risen

At less than 3 percent, the inflation figure for May is well within the target set by the government of India. This has led to a celebration in the media of the RBI’s prowess in macroeconomic management, of which inflation control is an important part. What has received next to no acknowledgement though is that in the same month unemployment has risen. Thus, while year-on year inflation fell from 3.2 in April to 2.8 percent in May, the unemployment rate rose from 5.1 percent in April to 5.8 percent in May. For those currently employed, as most commentators on the economy are, a reduction in inflation is certainly good news, at least to the extent that their purchasing power is now being eroded at a lower rate. But for those seeking employment it makes no difference. They remain unemployed. A branch of economic theory dominant in the United States holds that those unemployed have chosen not to work, as the market mechanism enables everyone who wishes to work to find employment. One needs only to visit the town centre in many semi-urban areas to find migrant labourers milling around at mid-day to see that this would be a preposterous claim to make for India. So, the first thing to note is that to monitor inflation while neglecting unemployment altogether, as the pundits do, is not a credible assessment of the state of an economy. While missing the higher unemployment rate may be overlooked, as it is not part of the discourse today, it is surprising that the considerable reduction in growth has not received as much attention, when it has been the centrepiece of the government’s pronouncements on the economy this past decade. The figures are as follows. GDP growth slid from 9.2 percent in 2023-24 to 6.5 percent in 2024-25. The observed rise in unemployment is consistent with this decline in growth.

The recently released provisional estimates of GDP by the National Statistics Office show the decline in growth to be spread across three quarters of the economy. Apart from Public Administration, for which growth was steady, every other sector grew slower in 2024-25. Agriculture alone grew faster, and much faster too. This datum provides the clue to the decline in inflation. In 2024-25, the relative rates of growth of the agricultural and non-agricultural sectors have been such as to lower the excess demand for agricultural goods, particularly food, contributing to a lowering of the inflation rate. This is evident in the sharp deceleration in food-price inflation from the peak of close to 11 percent in October 2024 to less than 1 percent in May 2025. Monetary policy, which is the RBI’s means for inflation control could not have achieved this configuration of events. It would be difficult to maintain that an increase in the repo rate in June 2022, the highest since, could have brought about as great a reduction in inflation in mid-2025. It is equally difficult to imagine that it could have brought about so widespread a slowing of the economy, especially in the services sector, which is unlikely to be much dependent upon credit. On the other hand, the impact of a narrowing difference in the rates of growth of the agricultural and non-agricultural sectors of the economy, as witnessed, can have a direct impact on the inflation rate. The reduction in food-price inflation impacts inflation directly, as food prices are part of the consumer price index, and indirectly via rising wages, which feed into  non-agricultural-goods inflation.

We have so far evaluated the role of monetary policy in a discursive manner. The economics profession usually settles empirical issues via econometric analysis, which is the application of statistical methods to economic models. This leaves little in doubt as to the efficacy of monetary policy. In our article “Inflation in India: Dynamics, distributional impact and policy implication”, (‘Structural change and Economic Dynamics’, June 2025), we demonstrate that there is no conclusive evidence of the role of the interest rate  in controlling inflation in India. On the other hand, there is conclusive evidence of the overwhelming role of the price of agricultural goods, driven by the relative rates of growth of the agricultural and non-agricultural sectors. Inflationary pressure generated by such a mechanism requires action on the supply side to be controlled. Inflation targeting, working via contraction of demand, is not a solution. If in the face of chronic excess demand for agricultural goods inflation is lowered by hiking the interest rate in order to restrain demand, other things remaining the same, inflation will rise as growth revives.

Two final observations should seal the debate on the role of the RBI in lowering the inflation rate today. First, an allegedly sophisticated view of ‘inflation targeting’, the model of inflation control adopted by the RBI, holds that a central bank can control inflation by influencing expectations of economic agents. When we study the RBI’s own data on the expectation of inflation by households we find that it has remained almost unchanged from March 2024 to May 2025, and is far greater than the RBI’s target rate of 4 percent. Therefore, the recent decline in inflation could not have been engineered by the said mechanism. Secondly, after the last meeting of the Monetary Policy Committee the Governor of the RBI stated that it is willing to lower the repo rate further if inflation continues to decline. Given the ineffectiveness of the repo rate in controlling inflation such a stance implies that it merely follows inflation rather than directing its course.