India's inflation has accelerated to a 44-month high of nearly 8%, giving a rude shock to the government. This article features the RBI and government policies to offset the inflation.

The current spurt in prices has its roots both in long-and short-term factors which have further accentuated with onset of recession in the world economy and possible signs of recession turning into depression in the US, the largest economy in the world. In a free market economy, movement of prices is an important indicator of the economic performance as the prices are considered an equilibrating force that brings about parity between aggregate demand and supply in the economy. The consumers, firms and government are the important contributors to aggregate demand and aggregate supply comes from the various producers of goods and services. At any point of time, it is difficult to match the anticipated demand and supply at the aggregate level and hence a mismatch does exist and extent of mismatch is reflected in the speed at which prices change. An increase in price means either increase in demand or fall in supply or a combination of both, leading to an increase in the gap between demand and supply.

The interplay between demand and supply occurs both in the real economy and the money economy. Any resultant imbalance can also result in inflation which is generally known as `more money chasing less goods', which has happened in the current US subprime case. The subprime crisis is one of the classic cases of `mispricing of risk' a result of huge flow of liquidity into the world economy and available at historical low interest rates as low as 1% in the US in 2003. The seeds for the current spiralling inflation were sown then. So the current phase of inflation has wider ramifications than what is currently being experienced and hence any half measures will not suffice to control. As the malady is rooted in the long-term inconsistencies, the solutions also should ideally be long-term in nature.

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