The usual tools are unlikely to fix our inflation problem

Context: High consumer and wholesale price inflation along with no/low growth means that India might enter into a stagflation phase. Traditional macroeconomic approach may not be optimum in such case. We need a more comprehensive set of policies to address the peculiar kind of inflation that India is facing. 

What is stagflation? 

Stagflation occurs when economic output stagnates but inflation keeps rising. It leads to unemployment and poor consumer demand. 

These localized micro-level factors and the high-level of uncertainty being faced by households and firms currently, means that inflation will be on incline. In such cases, monetary policy might be ineffective. 

What should be done instead? 

• Causes, such as pandemic-driven anxiety, rising uncertainty among consumers and capital scarcity among producers, require fiscal-monetary support measures that would allow consumer and producer sentiment to improve. 
• Direct income support: On the fiscal front, government should provide greater direct income support through unconditional cash transfers to households, giving them the means to spend.  

• This would help drive both private investment and employment.  
• Unconditional cash support would expand the capacity of all households to make discretionary expenditures. 

Why conditional cash transfers in such cases are difficult? 

• Increased allocation for our rural employment scheme would pay only those who work, and that too, on the assumption that there is work in those areas. 
• At a time when infections are rising in rural areas and mutant variants of the virus are infecting unvaccinated groups, little rural employment guarantee work may be available, or worse, people may be too afraid to leave home and go work. Conditional cash transfers in such times are less effective. 

Way forward 

Going forward, the key to framing a comprehensive response to inflationary tensions would be to pursue a localized and counter-cyclical (contrary to the fluctuations in an economic cycle) fiscal-monetary approach.  

• This should combine the instruments of direct government support with easy liquidity and bank credit provisions, so that firms and households have a wider set of choices. 

Conclusion 

Fixing supply disruptions solely through monetary policy tools, is likely to prove ineffective. It could even drive other aggregates like consumption and private investment demand into deeper recession. 

Terms to know 

• Monetary policy tools 
• Types of inflation 

Source: Livemint