and eventually affect growth. 18. a macro - econometric model of the indian economy shows that a 10 per cent sustained increase in real public investment in non - agriculture sector, financed by money creation leads to an annual inflation rate of about 2. 3 per cent and additional gdp growth of one percent, on an average, during the first two years, while in the span of 10 to 15 years, inflation rate rises to about 17 per cent per annum and additional output growth slows down considerably to average 2. 7 per cent during this period. this implies that in the long run a sustained improvement in the growth scenario through monetary financing of the deficit could involve a severe trade - off in terms of inflation - every one per cent additional output growth implies nearly 6 to 6. 5 per cent rise in inflation rate in the long run. 19. obviously, there are some critics of price stability as the dominant objective of monetary policy. for example prof. paul krugman writes ‘..... the belief that absolute price stability is a huge blessing, that it brings large benefits with few if any costs, rests not on evidence but on faith. the evidence actually points the other way : the benefits of price stability are elusive, the costs of getting there are large, and zero inflation may not be a good thing even in the long run. ’ the observations of prof. krugman as they stand are not directed against price stability as an objective but are aimed against a policy which seeks ‘ absolute ’ price stability and attempts to bring down the inflation rate from around two per cent to almost zero. this is evident from what he himself advocates : ‘..... adopt as a long run target fairly low but not zero inflation, say threefour per cent. this is high enough to accommodate most of the real wage cuts that markets impose, while the costs of the inflation itself will still be very small. interestingly, in india, the chakravarty committee ( 1985 ) treated an inflation rate of four per cent as ‘ the acceptable rise in prices ’ purported to reflect ‘ changes in relative prices necessary to attract resources to growth sectors ’. 20. we, in india, need to have an appropriate fix on the acceptable level of inflation rate. in the 1970s, the average annual inflation rate as measured by the wholesale price index was nine per cent. in the 1980s, it was eight per cent. however, in the period between 1990 and 1995, the average inflation rate has

of inflation the adverse consequences begin to set in. 15. inflation affects fiscal balance in several ways. it adversely affects fiscal deficit when elasticity of expenditure to inflation is higher than that of revenue. a more significant impact of inflation arises from its effect on interest rate and the dynamic sustainability of the fiscal situation. high rates of inflation signal weak resolve to control inflation and imply higher expected inflation in future. this gives rise to upward rigidity in nominal interest and leads to high debt service burden on the budget, thus reducing the manoeuvrability of fiscal management. 16. it is well recognised that adverse implications of inflation are higher at high rates of inflation, while a moderate inflation rate could be manageable without implying severe costs. international evidence suggests that the costs of uncertainty tend to rise in a non - linear fashion with inflation rate exceeding a threshold. one important caveat in interpreting the threshold of inflation rate beyond which costs exceed benefit is the provision of inflation protection measures available in the economy, which tends to moderate the adverse implications to some extent. countries with a moderate inflation rate but inadequate indexation provision may show a higher degree of sensitivity to inflation, than those with low inflation. most of the industrialised countries in the recent years have moved into an inflation rate ranging between two to three per cent. among the developing countries, some of the fast growing east - asian economies have in recent years not only demonstrated low inflation rates ranging between three to five per cent, but the growth rate at these inflation rates has been fairly high at around eight per cent. 17. empirical evidence on the relationship between the inflation and growth in cross - country frameworks is somewhat inconclusive because such studies include countries with inflation rate of as low as one to two per cent as well as countries with inflation rates going beyond 200 and 300 per cent. while a number of studies have concluded that the negative impact of inflation on growth is high at high rates of inflation, there is no consensus about the threshold inflation rate beyond which the negative impact becomes pronounced. a study by bruno indicated that growth rates declined steeply as the inflation rate went beyond 25 per cent. another study also based on cross section of countries reported that the negative effect of inflation was very pronounced and powerful at inflation rates exceeding eight per cent. what the appropriate inflation threshold beyond which costs tend to exceed benefits need to be estimated for each country separately. nevertheless, people worry about even moderate inflation levels because if not held in check, a little inflation can lead to higher inflation