We’re on a knife’s edge between global reflation and stagflation

News: Massive stimulus packages, given during the pandemic, could lead to high inflation amid low growth, if global production capacity lags overall demand.

Why the stimulus packages were given?

As the pandemic spread around the world, demand decreased due to fear and lockdowns. Services, travel, tourism, and retail operations took the hardest hits.

Firms around the world reacted with a swift reduction in capacity. Layoffs of employees followed, which decreased disposable income and contributed further to decreasing demand.

In this context, Central banks around the world responded with massive liquidity and monetary support, while governments relied on unprecedented fiscal spending.

What is the consequence?

– Demand pull Inflation: The increase in prices across various goods and services is now among the broadest the world has seen since the 1970s. From oil prices and food staples to semi-conductors and cars, prices have risen sharply.

– Supply Shocks: As demand recovered, this created massive supply bottlenecks, resulting in rising prices.

What are the implications for India?

For India and emerging markets, this environment is an opportunity as well as a challenge.

Opportunity

As one of the world’s fastest growing economies, India will continue to attract capital in a world of low interest rates, thus stabilizing its currency, current account and macro-economy.

This capital can help build on the economic gains of a vibrant startup sector that Indian entrepreneurs have shown a great propensity for.

Challenge

At the same time, without significant reforms in factor markets and material improvements in supply chains and logistics, rising demand will only add to India’s inflationary pressures.

What is the way forward?

Central bankers must remain vigilant on inflation. Sustained inflation disproportionately impacts the poor and vulnerable in any society.

Demand-led growth must prioritize investment instead of consumption. Otherwise, we risk stagflation, a rare but worrisome phenomenon of high inflation with low growth.

Source: This post is based on the article “We’re on a knife’s edge between global reflation and stagflation” published in Livemint on Dec 7^th 2021.