Economic reforms and relative price movements in India: a ‘supply shock’ approach

Abstract

This paper uses the ‘supply shock’ approach postulated by Ball and Mankiw to make an assessment of the reform process in India. In the presence of menu costs, a positively skewed distribution implies that more producers actually increase their prices than decrease them, leading to an increase in the inflation rate in the short run. This is tantamount to a negative supply shock. Conversely, a negatively skewed distribution indicates a positive supply shock. In this paper, we argue that a process of economic reforms has a direct short-run impact on relative prices, and can thus be viewed as providing a supply shock to the economy. We first statistically validate the supply shock argument for Indian data from 1982 to 1996. We then examine the behaviour of the skewness (and some other parameters) of the distribution of relative price changes over the four governments that India has had over this period. Somewhat surprisingly, we find that the properties of the distribution of relative price changes do not indicate the kind of positive supply shock that might have been expected, given the reforms that have been initiated.