Usual tools probably won’t solve our inflation problem


A temporal increase in inflation is inevitable as decentralized foreclosure restrictions are relaxed, as economic agents (e.g. businesses or households) would act on their own to decide what, where and how much to spend, regardless of whether it is sufficient the supply of a given product or service is available.

After weeks of closure in April and May, if people want to have their hair cut in a salon, for example, its price would depend on the number of salon owners open and the number of hairdressers returning to work. These factors do not work in tandem. Salon owners may take a while to open up while still ensuring that covid protocols are in place so consumers feel safe. They would operate at low capacity (taking fewer appointments) and most hairdressers might be reluctant to work or demand higher wages for their risk of exposure to infection. These factors could drive up the overall price of a haircut (or other salon services).

Likewise, in an informal space, if a chai-waala operating near a construction site in Delhi sees a surge in demand for tea after unlocking, it would immediately need more milk from it. its usual distributor. If the source of that milk happens to be a dairy farm in a state where covid restrictions are still in place, then the milk supply could be interrupted or delayed. In such a scenario, the price of tea would increase.

Interpreting such observations at the micro level, I had predicted a rise in the Consumer Price Index in May, which is now materializing. An interplay of localized factors has combined with a high degree of uncertainty in the lives and livelihoods of various economic agents across India which is likely to keep inflation on a slope. It is extremely difficult to adopt a stereotypical approach to dealing with such a rise in inflation expectations. Monetary policy can be ineffective.

The Reserve Bank of India and most other central banks in emerging economies find themselves powerless to achieve their primary inflation-containment objective, as the drivers of local inflation are no longer solely the result of local inflation. causal binaries of demand and / or cost surge (which are relevant in normal times).

New behavioral causes, such as anxiety over a pandemic, growing uncertainty among consumers, and scarcity of capital among producers, heighten the need to use interwoven fiscal and monetary support measures that would build confidence. for consumers and producers to improve, which is the key to getting India’s economy out of the “Keynesian downfall” in which it finds itself.

On the fiscal side, what is needed at this stage is the provision of more direct income support through unconditional cash transfers to households, empowering them to spend. This would help stimulate both private investment and employment. It is important to clarify that at this stage, targeted support programs are less likely to be effective.

Unconditional cash support would increase the ability of all households to spend discretionary. Any substitute support in the form of rations, food stamps or other in-kind transfers will not help. Even an increased allowance for our rural employment program would only pay those who work, and that too, assuming there is work in those areas.

At a time when infections are on the rise in rural areas and mutant variants of the virus infect unvaccinated groups, few rural jobs may guarantee employment or, worse yet, people may be too afraid to leave their homes. home and going to work. Conditional cash transfers at these times are less effective.

Therefore, it is essential to think creatively and design localized fiscal interventions to support monetary policy thinking. But I’m not sure if most macroeconomists, including those on the Indian policymaking spectrum, recognize these intricacies at the micro level.

The other issue is how most central banks still tend to operate within an operational and functional framework that overshadows Milton Friedman’s work. We are already seeing evidence of how the design of monetary policy and central bank autonomy is becoming an institutionalized myth across nations. Keynes biographer Robert Skidelsky has pointed out how the reluctance to admit the relevance of Keynesian theory on monetarism has distorted the language of macroeconomic policy (

In India, we have seen the central bank take a lot of the responsibility for providing lifelines. Its recent quantitative easing of liquidity in response to the covid-induced economic crisis was a veiled attempt by the government to have monetary methods used as a substitute for direct fiscal intervention.

Going forward, the key to crafting a comprehensive response to inflationary pressures would be to pursue a localized, countercyclical fiscal-monetary approach that combines the instruments of direct government support with easy liquidity and bank lending arrangements, so that economic agents have a wider set of choices.

A monolithic macro approach to dealing with a temporal rise in inflation, or an effort to address supply disruptions only through a monetary policy toolkit, is likely to prove ineffective. It could even push other aggregates like consumption and demand for private investment into a deeper recession.

Deepanshu Mohan is Associate Professor of Economics at OP Jindal Global University

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