South Asian Journal of Macroeconomics and Public Finance 4 (1)
Stylized Indian facts and structural features are consistent with an elastic aggregate supply, subject to cost push. A variety of time series tests sup-port this against an alternative hypothesis of inelastic supply. Mechanisms that propagate relative price changes into the price level include sector bottlenecks and governance failures. The first best policy response to a temporary supply shock is to shift down the supply curve by neutralizing mechanisms that propagate supply shocks, while avoiding too large a demand contraction. A standard monetary tightening to anchor inflation expectations requires a large growth sacrifice. Backward-looking price setting in some Indian firms reduces the required intensity of tightening.