India is Facing Stagflation - Know Why? - Seeker's Thoughts

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India is Facing Stagflation - Know Why?


With fast decelerating economic growth and sharply rising inflation, there is a growing rumor about India facing stagflation.



The worsening trend has also been spotted in the Consumer Price Index (CPI) as an increase in food prices lifted the November retail inflation to 5.54% from 4.62% in October.



But, the industrial output measured through the index of industrial production (IIP) suggests that downward production spiral has somewhat been arrested with the October output declining only 3.8% against 4.3% in September.


The factory output growth rate in October was nowhere near the rise of 8.4% recorded in the year-ago month.

An associate professor in the economy at Jawaharlal Nehru University believes the breakdown is neither a result of one off event such as demonetization, nor a technical problem. He listed the reasons for the collapse of domestic demand and the economic crisis India is facing. He also explained why the government has limited room to maneuvers and bring the economy back on track.



 The Reserve Bank of India (RBI) has confirmed what all of us knew. Demonetization caused much pain without any gain. What Kind, what level of pair, and where it was inflicted are still playing out. India is witnessed some of the negative effects of demonetization on the economy. But demonetization was not the trigger for the economic collapse one is witnessing today.


The data is clear on this. Since 2015-2016, growth rates have been going down. It is not as if the 5.7% growth rate for this quarter has come about suddenly. These numbers represent a very serious set of problems with the economy. And, those problems have been neglected for a long period of time, which is why they have come to bite us today.


Some of these problems began in 2013-2014. Wages had started turning negative in real terms since 2013. The problem of non-performing assets (NPAs) had appeared by then. The global recession was visible. These factors were well-known. The one big trigger that came around the time the present government took over was in August 2014, when primary commodity prices collapsed following a fall in oil prices. This hit farmer incomes hard.



What is Stagflation?

Simply put, Stagflation is a portmanteau of stagnant growth and rising inflation. Typically, inflation rises when the economy is growing fast. That's because people are earning more and more money and are capable of paying higher prices for the same quantity of goods. When the economy stalls, inflation tends to dip as well – again because there is less money now chasing the same quantity of goods.

                                
Stagflation is said to happen when an economy faces stagnant growth as well as persistently high inflation. In other words, the worst of both worlds. That's because with stalled economic growth, unemployment tends to rise and existing incomes do not rise fast enough and yet, people have to contend with rising inflation. So people find themselves pressurized from both sides as their purchasing power is reduced.

When does stagflation occur?

Stagflation is said to happen when an economy faces stagnant growth as well as persistently high inflation.

That because with stalled economic growth, unemployment tends to rise and existing incomes do not rise fast enough and yet, people have contended with rising inflation.

So people find themselves pressurized from both sides as their purchasing power is reduced.


What are the reasons India is currently facing stagflation?


First – GDP hasn’t declined –

 Although it is true that India is not growing as fast as it grown in the past or as fast as India could, India is still growing at 5% and is expected to grow faster in the coming years. India’s growth hasn’t yet stalled.


Second – Food inflation is predictable –

It is true that retail inflation has been quite high in the past few months, yet the reason for this spike is temporary because it has been caused by a sort in agricultural commodities after some unseasonable rains.

With better food management, food inflation can be expected to come down.



Last – Retail inflation is under control

Lastly inflation has been well within the RBI’s target level 4% for most of the year. The core inflation – that is inflation without taking into account food and fuel- is till benign.

A sudden spike of a few months, which is likely to flatten out in the next few months, it is still early days before one claims that India has stagflation.

Creating jobs is still a challenge in India


Types of inflation

·         Creeping or mild inflation is when prices rise 3% a year or less.

·         Walking inflation is strong, or pernicious, inflation between 3-10% a year.

·         Galloping inflation occurs when inflation rises to 10% or more.

·         Hyperinflation is when prices skyrocket more than 50% a month.

·         Deflation occurs when there is a general fall in the level of prices

·         Disinflation is the reduction of the rate of inflation

·         Stagflation is a combination of inflation and rising unemployment due to recession



How to solve stagflation?

It’s not that easy. For example, the RBI could use monetary policy to try and reduce inflation. Higher interest rates increased the cost of borrowing and this reduce aggregate demand. This will be effective for reducing inflation, but, it will cause a bigger fall in GDP. Therefore, the Central Bank may be reluctant to target inflation when growth is already low.

In 2008/09, the Bank if England tolerated cost-pus inflation of 5% because they were concerned about the UK economic growth.


If the Marginal propensity to consume (MPC) cut rates to try and increase GDP, they make inflation worse. Their demand-side policies struggle to solve stagflation they only solve one particular aspect.


About MPC – In economics, the marginal propensity to consume is a metric that quantities induced consumption, the concept that the increase in personal consumer spending consumption occurs with an increase in disposable income (income after taxes and transfers).



Monetarist view

The monetarist view is that the primary macroeconomic objective should be to reduce inflation. Reducing inflation may cause higher unemployment and lower economic growth in the short term. But this unemployment is a price worth paying for higher inflation.

This is the approach of the UK conservative government 1979-84 – which pursued deflationary policies to get rid of inflation.


However the question is how a reduction in inflation would work when India is already facing higher unemployment and slow economic growth?

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One solution to stagflation is to increase aggregate supply AS through supply-side policies, for example, privatization and deregulation to increase efficiency and reduce the cost of production. However. These will take a long time. Also, if the cost-push inflation occurs because of a global increase in the price of oil and food. That would be a difficult task to control stagflation for India.



However, often cost push inflation is a temporary affair e.g. rising energy prices may not continue forever. There, it is something that needs to be done tolerated.


Wage control can be the other option to curb stagflation. In the 1970s part of the stagflation was caused by rising wages (powerful trade unions). A policy tried was wage control – government intervention to limit wage rises. In theory, limiting wage increases can break the cycle of wage inflation and help to improve the economic situation. In practicing wage control is fairly difficult to implement and had little impact on solving stagflation.


Conclusion

For the economy to overcome the issue of stagflation, government need to work hand-in-hand with the central bank, thus the central bank by contractionary monetary policy (reduce money supply buy increasing interest rates to overcome inflation) in a short-run and government by expansionary fiscal policy (reduce spending and increasing tax rate to overcome unemployment, and invest money on treasury-bonds, infrastructure, Public-works, etc) though it might take time to implement


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