Is the Indian economy staring at stagflation? (The Hindu)

Mains Paper 3:- Economy
Prelims level:- Stagflation
Mains level:- Affecting stagflation in an economy

Context:

• The rise in retail price inflation to a nearly six-year high of 7.35% in December has led to increasing worries that the Indian economy may be headed towards stagflation.
• The current rise in retail inflation has been attributed mainly to the rise in the prices of vegetables such as onions.
• Still, the steady rise in wider inflation figures over the last few months amidst falling economic growth has led to fears of stagflation.

What is stagflation?

• Stagflation is an economic scenario where an economy faces both high inflation and low growth (and high unemployment) at the same time.
• The Indian economy has now faced six consecutive quarters of slowing growth since 2018.
• Economic growth in the second quarter ending September, the most recent quarter for which data is available, was just 4.5%. For the whole year, growth is expected to be around 5%.
• Most economists have blamed the slowdown on the lack of sufficient consumer demand for goods and services.
• In fact, insufficient demand was cited as the primary reason behind the low price inflation that was prevalent in the economy until recently.
• The expectation among analysts was that these interest rate cuts would spur demand and boost the economy.
• In the second half of 2019, prices of goods began to rise at a faster pace on the back of the RBI’s rate cuts. But the growth rate of the economy continued to fall significantly. This combination of rising prices and falling growth has led many to believe that India may be sliding into stagflation.
• The only thing right now that stops many from concluding that the economy is in full-fledged stagflation is the fact that core inflation, which excludes items such as vegetables whose prices are too volatile, remains within the RBI’s targeted range.

Can economists explain stagflation?

• The conventional view among economists is that there is an inverse relationship between economic growth and inflation.
• The idea was first proposed by New Zealand economist William Phillips, after whom the “Phillips Curve” is named, based on statistical studies of inflation and unemployment. It later gained widespread acceptance among mainstream economists.
• The inverse relationship between inflation and unemployment was seen as a confirmation of the hypothesis that inflation helps the economy function at its full potential.
• The logic behind the belief is that, at least in the short term, inflation (by boosting nominal wages but not real wages) can trick workers in an economy to accept lower real wages.
• Without inflation, it is argued, workers would be unwilling to accept these lower real wages, which in turn would lead to higher unemployment and decreased output in the economy.
• At the same time, economists argue that an inflation rate beyond a certain level, at which point labour and other resources in the economy are fully employed, will have no employment or growth benefits.
• Accordingly, policymakers are often advised to maintain a certain inflation rate to ensure that unemployment is kept to a minimum and the economy is operating at full capacity.
• The simultaneous presence of high inflation and low economic growth under stagflation, however, challenges the conventional view that inflation helps an economy operate at full capacity.
• It was the stagflation in the United States in the 1970s, caused by rising oil prices after the Organization of the Petroleum Exporting Countries cut supplies abruptly, which first led many to question the validity of the Phillips Curve.

Why is stagflation a problem?

• Economists who believe that the current slowdown is due to the lack of sufficient consumer demand prescribe greater spending by the government and the central bank to resuscitate the economy.
• But stagflation essentially ties the hands of the government and the central bank from taking such countercyclical policy steps.
• With retail inflation now well above the RBI’s targeted range of 2-6%, the central bank is unlikely to assist the economy any time soon by cutting its benchmark interest rate.
• If the central bank decides to inject fresh money into the economy either by cutting its benchmark interest rate or other unconventional means, it could lead to a further rise in prices and make things worse. A similar rise in inflation could result if the government engages in deficit spending that is funded by the RBI.
• All this is considered to be bad news at a time when the economy, with significant unemployed resources, is not functioning at its full capacity.
• Stagflation can also be politically costly to the ruling government.
• On the one hand, the slowdown in growth could affect peoples’ incomes. On the other, higher inflation could cause a reduction in people’s standard of living as they can afford fewer things.

Way forward:

• Economists are divided along ideological lines on what needs to be done for an economy to recover from stagflation.
• Some economists suggest that policymakers should stop worrying about inflation and instead focus exclusively on boosting aggregate demand in the economy.
• India’s nominal GDP growth, a measure of the overall level of spending in the economy, is expected to hit a 42-year low of 7.5% this year.
• They consider the RBI’s target of keeping inflation from rising above 6% as an arbitrary one and believe that the central bank should further ease its policy stance and the government should spend more on infrastructure and other sectors to boost the economy.
• Another point raised by these economists is that inflation on the broader level, as measured by the core inflation figures, remains within the RBI’s target range.
• Core inflation in December was at 3.7%. So greater spending by the government and the RBI will not cause inflation levels to run out of control, they argue.

Conclusion:

• India’s growth rate, it is worth noting, was boosted by the availability of easy credit over the last decade, or even longer.
• Further credit expansion by the central bank and debt-fuelled government spending, these economists argue, will not lead to genuine and sustainable economic growth but only to another unsustainable boom followed by a bust.
• So they instead advocate supply-side reforms to bring about genuine economic growth.

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Prelims Questions:

Q.1) Which of the following languages enjoy the ‘Classical’ status in India?
1. Tamil
2. Sanskrit
3. Malayalam
4. Hindi

Which of the statements given above is/are correct?
(a) 1 and 4 only
(b) 2 and 3 only
(c) 1, 2 and 3 only
(d) All the above

Answer: C
Mains Questions:
Q.1) Why is the scenario of rising prices and falling growth a cause for worry? Can the government or the Reserve Bank of India do anything?