Now, some inflation has become important to contain the inflation target...

RBI must include unemployment rate in its model... Lower growth could also mean higher unemployment... 11% growth in 2011 reduced unemployment to 6%... which is still above the natural rate of 5%... Potential rate is decided by the rate of population growth rate (17% per ten year) minus frictional unemployment (5%), which is present all the time. That means INDIA can grow to achieve 12% on average... INDIA achieved 11% growth rate which is less 1% than its potential 12%... and unemployment could go more 1% down to touch the 5% threshold... Therefore, if the current growth rate is 6.1% we could expect that unemployment might have gone up 11%... which might need substantial rate cuts ahead... NPAs too have reduced confidence...

We have lower price level and price level expectations upto full employment because supply would increase with lower unemployment or higher employment and lower borrowing cost and higher price and price expectations after full employment due to low scope of increasing supply due to scarce labour and higher borrowing cost, however the purpose is to stabilize or constant the price level and price level expectations at full employment and neutral or constant unemployment and constant supply and neutral borrowing cost….

Lower inflation and lower inflation expectation have also increased the rate cut and expectations. However, inflation in 2011 was close to 8% with all the supply side constraints and mismanagement, but CPI at 1.5% in June has revitalized rate cut expectations and higher unemployment and low growth also point rate cuts and expectations. However, if we use the reasoning or logic in the above paragraph that would also indicate rate cut and rate cut expectations… The inflation in INDIA is often ascribed to the supply side weakness and higher demand, too, but this time it is a different situation, INDIA has improved a lot on the supply side and inflation has gone down, also due to higher unemployment and higher borrowing cost which are further likely to reduce the price level through lower borrowing cost, higher investment and higher employment, higher demand and higher supply. In INDIA there is enough scope to increase supply, demand and growth by lowering the borrowing cost and the unemployment rate. Lower borrowing cost might help to sustain inflation around the target 4%. This time by not lowering the interest rate the RBI is expected to ditch its inflation targeting itself… Now, some inflation has become important to contain the inflation target. Lower borrowing cost would increase investment, employment and growth to hit the inflation target… Lower borrowing cost may also help the commercial banks and businesses to reduce NPAs by adjusting margins…