I wrote an article Reddy & Bernanke in Business Standard today, in reaction to the RBI rate hike, and placing it in the context of developments outside India.
The outstanding fact of Indian macro in recent times is the acceleration of CPI inflation, which rose from 3% in late 2003 to between 6% and 7% today. Further, the inadequate response of monetary policy in this episode generates expectations on the part of households and firms that in the future, a rise in inflation will be persistent. Mature market economies have stable inflation and unstable exchange rates; in the third world it is upside down.
I argue that India continues to need tight monetary policy, so as to get CPI inflation back to the 3% which had been achieved in late 2003. The situation in the US is much more cloudy - if a recession sets in within a few months, the Fed might be cutting rates. This underlines the idea that India is a large economy which requires a monetary policy based on the domestic business cycle, and the use of US monetary policy (by running a pegged exchange rate) is not optimal for India.
Hmm, while on this note, it was interesting to then see Chidambaram using the phrase `inflationary expectations' in this speech. Maybe caring deeply about inflation persistence and the expectations of households & firms isn't a disease of economists only :-)