All you wanted to know about stagflation

Inflation has always been a bugbear for Indians, cropping up to dent their finances when they least expect it. But after recent inflation readings, commentators are worrying about a new risk — stagflation.

While GDP growth is expected to tumble to a low of 5 per cent for FY20, and consumer price inflation is at a near six-year high of 7.59 per cent for January, economists have begun to debate if the economy is moving towards stagflation.

Stagflation is an economic phenomenon marked by a combination of recession and high inflation. But until 1970s, stagflation was believed to be quite an improbable scenario as a slowing economy usually prevents high inflation by quelling demand. However, subsequent events have struck a blow to this notion. For instance, in the year 1973, during the oil shock, global economies witnessed sharp setbacks on the back of spiralling oil prices.

This led to an upward spiral in inflation as higher fuel costs fed into transportation costs and ultimately resulted in higher priced goods and services. Inflation kept rising even as people were being laid off.

Similarly, stagflation could occur if loose monetary policies or stimulus measures fail to lift an economy out of a slowdown, even as they stoke price rise.

Stagflation if not nipped in the bud can be dangerous, because it aggravates pain for consumers at a time when economic output and incomes are barely growing. Persisting stagflation can push middle-class folks below the poverty line.

However, it isn’t easy to tackle either. In fact, the very measures taken by policymakers to address stagflation can aggravate it. For example, if the central bank increases interest rates in a bid to tame inflation, then it could increase the cost of borrowings and reduce the aggregate demand, worsening the slowdown. On the other hand, if it cuts interest rates to induce growth, this could make inflation worse.

Stagflation therefore calls for solutions beyond the conventional monetary or fiscal policy tools. Further, an economy in stagflation can be politically costly to the ruling government.

However, it is early days yet to assert that India is facing stagflation. India’s GDP growth is expected to chart a recovery of sorts in the second half of FY21. Inflation, which rose due to spike in food prices on the back of heavy rains, could moderate, in the coming months.

The Chief Economic Adviser has expressed the view that the inflation spike is temporary.

But the rising inflation print does leave policymakers in a dilemma. With retail inflation well above its targeted range of 2-6 per cent, the Monetary Policy Committee seems hesitant to cut rates.

The government has been hesitating to let its fiscal deficit shoot past its comfort zone as it could again lead to a rise in inflation.

Imagine a situation where your monthly expenses towards groceries, rent, fuel et al are galloping but your employer is holding off increments, or even threatening a pink slip. An economy is said to be in stagflation when the country’s GDP (Gross Domestic Product) is growing at a slow rate, even as inflation is rising.

Usually, a slowdown in GDP growth indicates sluggish income growth and a poor environment for investments, which can lead to low job growth or even lay-offs of workers to save costs. Stagflation leaves consumers with less money to spend, even as it escalates the costs of goods or services. Stagflation can be pretty bad for savers and investors too, as the money saved and invested is eroded by the inflation.

Stagflation can bring more tears to the eyes than onion prices.

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