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The inflation-growth trade-off and the role of monetary policy in India have received renewed interest among policymakers and academics in recent years as persistently high inflation and weak growth happened to coexist. 1 The conventional view is that inflation at low levels greases the wheels of an economy, while at high levels it negatively affects allocative efficiency and growth. In other words, while the short-term Phillips curve postulates that inflation tolerance could be associated with higher growth, persistently high inflation by itself, and especially beyond a certain threshold, could be a drag on economic growth in the long term.

This chapter revisits the nonlinear effects of inflation on growth in India, and investigates whether a persistently elevated inflation rate (particularly above a certain threshold) could slow economic growth in the long term. Given that estimating the inflation threshold in a cross-country framework runs the risk of being distorted because of cross-country heterogeneity, 2 we instead rely on Indian state-level GDP growth and inflation data, and a heterogeneous panel technique, to estimate the inflation threshold for India. This allows for a more accurate and efficient inference of model parameters than from time-series regressions using all-India consumer price index (CPI) data or from cross-country panel data models.