A cycle of low growth, higher inflation (The Hindu, GS-3, Economics, Inflation)

Context:- Many economists are arguing that the Government does not need to do anything with the economy and that it will revive by itself. They call the economists doomsday merchants who disagree with them. The reason behind such reasoning by these economists is the Great Depression, the economy rebounded worldwide, and so will it with us.

What is Inflation:-

  • Inflation is the rise in the general level of prices of goods and services in an economy over a period of time.  
  • Deflation is the inverse of the above definition. 
    • Deflation occurs when the inflation rate falls below 0% 

    • British Economist J.M.Keynes (1883) In his book “General Theory on employment, interest, money” said that  “when economy is functioning at full employment, aggregate supply will match aggregate demand.” At this equilibrium, we’ll have ‘General Price’ level this will led to any increase inflation or if it decrease then led to deflation.

    • Demand Pull Inflation:- It’s ‘too much money chasing too few goods’ i.e. Prices are rising because people have excess money , It means demand for goods and services exceeds the available supply. 
    • Monetary inflation:-When RBI printing of more money results in inflation . 
    • Repressed Inflation:- During war, Govt imposes price controls and rationing to keep prices under check. But the moment such controls are withdrawn, prices will go up (because traders will want to cover up their previous losses by raising prices). This is called Repressed Inflation. 
    • Stagflation:- a continuous high inflation along with high unemployment and low growth resulting in a stagnant economy. 
    • Skewflation:- It denotes episodic price rise in one / small group of commodities while Inflation in the remaining goods and services remain usual. E.g. pulse /onion inflation in india. 
    • Headline Inflation:-  It is the measure of the total inflation within an economy, usually presented in the form of CPI or WPI

There are 4 factors which shows why government should intervene now:-

    • The first factor is demand. 

      • In the case of the Great Depression in 1929, demand was created by the Second World War where the USA was the main supplier. But now, there is no war to create demand and top of it the COVID­19 pandemic has destroyed the demand. This is because there have been pay cuts, many jobs have been lost, and even jobs were reduced.
  • 2nd Factor is inflation:-

      • India is suffering from stagnant growth to low growth in the last two quarters in particular but in the last few years as whole. 
      • At best, any growth in the current quarter will be illusionary or create a pseudo effect of growth because of “low base effect”.
        • What is base effect:-
          •  For example, the price of 1 kg orange = 200 (2010), 220 (2011), 240 (2012). So, as such their price is increasing at the rate of ₹ 20 per year.
          • But the % rise in inflation over previous year is 0% for 2011 (220 vs 200), and 9.09% for 2012 (=240 vs 220). Thus, the choice of base (denominator) could make the inflation look too high or too low even if the price rise has been the same. 
  • What causes inflation in India:-

        • combination of high commodity prices along with high asset price inflation caused by ultra loose monetary policy followed across the globe such as USA ease money policy.
        • Foreign portfolio investors have invested a portion of the liquidity in our markets, the problem is that India has a relatively low market capitalization as compared to a developed capital market such as that of the U.S. so it cannot absorb the enormous capital inflow without asset prices inflation.
        • Supply chain bottlenecks have also contributed to inflation.
        • Scarce supply of goods because of COVID­19.
        •  India’s usurious taxation policy on fuel has created a ruckus.
        •  RBI is infusing massive liquidity into the system by following an expansionary monetary policy through the G­SAP, or Government Securities Acquisition Programme, thereby chasing too much money chasing few goods and causing inflation.
  • The third is interest rates:-

      • Rising interest rates have led to a decrease in aggregate demand in a country which ultimately affects the GDP.
  • 4th factor is rising non performing assets, or NPA in india Banking Sector:-

    • Rising interest rates along with lack of liquidity in indian banking system
    • Offering credit to leveraged or MNCs companies instead of direct subsidies to support small and medium sized enterprises (SMEs) and micro, small and medium enterprises (MSMEs) to counter the COVID­19 pandemic
      • This all led to an increase in NPAs of public sector banks climbing faster. 

Way Forward:-

  • Our public sector unit and several other banks will need capital to make up for bad debt.
  • More money at the people’s disposal so that people can spend and revive the demand in the economy.
  • The Indian economy is in a vicious cycle of low growth and higher inflation so an urgent policy action will ensures higher demand and growth.

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