Let us go back to the USA of the 1970s. A never-observed before disturbing trend is on the rise. Soon, it comes to the notice of Classical Economists.
- They observe a decline in general productivity levels.
- Unemployment levels are on the rise.
- However, the prices are increasing every day.
Now, the question here is, how can price levels rise when people are unemployed and not ready to splurge on stuff? The entire situation made no sense to the Economists but they didn’t want to give up. They turned to oil to look for answers. Around that time, the oil-producing nations had imposed an embargo on the USA and refused to continue shipping oil. With the supply of oil dwindling all of a sudden, prices sky-rocketed very quickly and took the costs along with them. As energy production became expensive, retail prices inched up too. The entire prognosis was debated highly and was referred to as a unique case, leading to the coining of a special term for this phenomenon- stagflation.
Stagflation is defined as a period of rising inflation accompanied by falling output and rising unemployment levels. The term was originally coined in 1965 by a British Politician. However, it entered popular discourse during the 1970s when it was adopted to explain the happenings in the USA. A degree of stagflation was also observed in 2008, shortly before the world economies entered recession. The major causes of stagflation could be:
- Oil-price rise: A supply-side shock increases costs. Such increases in turn flare inflation and lower the GDP due to a shift in the short-run aggregate supply.
- Trading Unions: If trade unions enjoy a higher bargaining power, they demand higher wages even during low economic growth, contributing as a cause of inflation.
- Falling Productivity: Inefficient workers are responsible for increasing costs and lowering the output levels.
- Rise of Structural Unemployment: A decrease in traditional industries causes this and a decrease in output levels, adding to inflation levels.
The catch here is that the monetary policy can either increase interest rates to counter inflation or cut rates to boost economic growth. Stagflation is an amalgamation of inflation and deflation hence, becomes a tricky business to solve. A few of its model solutions suggest decreasing economic dependency on oil and boosting the supply-side policies to increase productivity without pushing inflation.
So, if anyone flags stagflation concerns in our own backyard, we have very good reasons to be concerned. In fact, last year in November, this is what former Prime Minister, Dr. Manmohan Singh warned about, that India was going down the same rabbit hole. Months later, RBI’s household survey also pointed out the same things. You could see people being laid off, prices were expected to rise and the economy was at a standstill.
India, reeling under the immense pressure of the Covid-19 pandemic, finds itself facing this painful trend. The intermittent lockdown and the higher money supply for the flare of the inflationary pressures have added to our vows. The lockdown led to supply side disruptions for perishable agricultural goods, pushing production costs and contributing to the inflation of food items. It was quite natural to see the spurt in inflationary figures. This also led to the RBI Monetary Policy Committee to hold its rates in August.
Many people have to say that the entire process may be more cyclic in nature, due to the sudden pandemic and ensuing lockdown. As the restrictions have eased out and the economy is opening up again, ideally production costs should normalize. In the string of events that will follow, prices should normalize as well. Yes, we still have job losses and GDP to worry about, but battling inflation while grappling with these two issues is itself a nightmare. Hopefully, stagflation won’t be an addition to it.