The great inflation conundrum that policymakers must resolve

News: Economies around the world, including Argentina, Brazil, Turkey, India, and, most importantly, the US are witnessing an increase in price levels.

The increase of inflation in the U.S and other economies will have adverse effects worldwide because its spill over effects are far-reaching.

What has been the inflation trend across the countries?

While present inflationary trends have a common cause, namely, the rebound from the pandemic-induced slowdown, countries’ diverse responses to this novel crisis have led to varied economic performance.

U.S: Some experts think that the current inflationary pressure is a short-term episode triggered by supply-chain disruptions. While others see it as the result of the large spending under US President Joe Biden’s American Rescue Plan.

As a result of sustained inflation, Americans expect their financial situation to worsen in the near term, a level of pessimism not seen since the Great Recession of 2008-09.

Turkey: Turkey has an alarming annual inflation rate of 19.9%. Making matters worse, its president Recep Tayyip Erdoğan believes the right response is to reduce interest rates. However, reducing interest rates will not be a good policy choice for now.

Brazil: Brazil has recently joined the list of countries with double-digit price growth. Inept policymaking by the government has created fears that the economy is on the verge of a technical recession.

How India’s experience has been till now?

India, especially, faces a tricky inflation problem. Retail inflation is elevated but not at the level seen in many other economies.

But wholesale price inflation, that increased sharply to 12.5% year-on-year in October, has reached its highest levels since the late 1990s. This poses an unusual policy challenge.

Why India’s inflation issue is said to be tricky?

The wide divergence between wholesale and retail inflation is impacting the small manufacturers, the self-employed and workers.

Those who buy from the wholesale market and sell on the retail market are seeing a fall in their profits. They are cutting back production and this, in turn, is adversely affecting workers.

Here is the problem:

– If this divergence is allowed to persist, growth will likely decline as small businesses, already under strain, reduce output and cut employment and possibly shut down.

– But if the government tries to narrow the gap by letting retail inflation rise, consumers will be hit hard.

What is the way out for India?

The only reasonable way out is for policymakers to tackle wholesale price inflation directly.

This will require a combination of fiscal and monetary measures, like reducing the high tax on fuel and slashing all non-essential spending while also supporting those hit hardest by the pandemic.

It may also be time for the Reserve Bank of India to consider hiking interest rates.

Source: This post is based on the article “The great inflation conundrum that policymakers must resolve” published in Livemint on 29th Nov 2021.