Taming inflation without inhibiting growth

The World Bank has come out with a report that holds out the prospect of a global recession in 2023. The report calls for some very delicately-balanced trade-offs in emerging markets and developing economies between fighting inflation and preserving growth.

Background

• India’s GDP growth rate had been decelerating sharply over the three years leading up to the Covid-19
• It decelerated from more than 8% in 2016-17 to less than 4% in 2019-20.
• Issues faced by India: Currently, India faces the problem of:
  • chronically low employment
  • high fiscal deficit (targeted 6.4 percent in fiscal 2023 versus the norm of 4 percent of GDP)
  • low private capital investment
  • a slow post-pandemic economic recovery
  • very shallow and leaky social and unemployment support systems

What is the essential problem?

• If RBI continues to tighten monetary policy, it will weaken economic recovery at a time when growth is already faltering and unemployment is already quite high.
• If RBI ignores inflation then it hits the poor immediately without necessarily guaranteeing that growth and unemployment will be resolved.

What is the trade-off between growth and inflation?

• In any economy, there are two overwhelming concerns for policymakers: promoting fast economic growth, and maintaining price stability. Both are important.
• If fast economic growth comes with a high level of inflation then it undermines future growth in two broad ways.
  • Change in consumer behaviour: if prices are rising fast, it makes sense to buy things today rather than wait for tomorrow. But when everyone — or at least a large number of people — starts behaving like this, it only stokes inflation further. Prices rise faster because everyone starts demanding goods today even when they do not need them.
  • Change in producer behaviour: If the price of inputs rises fast, it can eat into the producer’s profitability. If the producer passes on the higher prices to consumers — and not every producer is in a position to do that — it can bring down the demand for the product, and they can lose crucial market share that took years, even decades to build.

How RBI manages the situation?

• Raises interest rates: To contain inflation, RBI makes it costlier for consumers to borrow and consume and for producers to borrow and produce — thus slowing down overall economic activity.
• Reduces interest rates: To promote growth, it reduces interest rates, thus giving a boost to credit-driven consumption and production.

What if the inflation becomes high at a time when economic growth is faltering?

• This is one of the worst scenarios for policymakers.
• That’s because measures to contain inflation — such as raising interest rates — now risk running the economy aground.

Suggestive measures

The WHO report urges the following measures, apart from monetary, and fiscal measures:

• ease labour-market constraints, increase labour-force participation, and reduce price pressures
• boost the global supply of commodities, in particular, supplies of food and energy, while accelerating the transition to low–carbon energy sources economising on energy consumption
• Strengthen global trade, removing global supply bottlenecks, and guarding against the threat of protectionism and fragmentation that could further disrupt trade networks.