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16 September 2022 – The Hindu

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Staglation

 Stagflation’s definition:

Stagflation is defined as a period of slow economic growth and relatively high unemployment, as well as rising prices (i.e., inflation). It is defined as an inflationary era followed by a decline in the gross domestic product (GDP).

History of Stagflation:

  • In the context of Keynesian economics, the Phillips Curve economic theory described macroeconomic policy as a trade-off between unemployment and inflation.
  • Every declared recession in the United States over the previous 50 years has seen consumer prices climb year over year.
  • The sole exception was during the financial crisis of 2008, and even then, price reductions were limited to energy expenses, while other consumer prices continued to rise.
  • In October 1973, the Organization of Petroleum Exporting Countries (OPEC) declared an embargo on Western nations. This caused the price of oil to spike over the world, rising the cost of commodities and increasing unemployment.

Inflation and Unemployment: What’s the Connection?

  • The Phillips curve, which attempted to prove a negative empirical relationship between unemployment and inflation, is strongly tied to stagflation.
  • According to the Philips curve, when unemployment is high, inflation is low, and when unemployment is low, inflation is high.
  • The apparent negative relationship between unemployment and inflation, according to Keynesian economists, is a natural phenomena caused by sticky pricing.
  • According to these economists, unemployment rises when wages do not decline quickly enough to keep up with changing economic conditions.
  • Workers are thought to be resistant to salary cutbacks, forcing businesses to fire specific employees in order to adjust to higher salaries rather than lower pay. Because there are fewer people working, this can have an influence on an economy’s overall output.
  • Economists felt that if prices climbed at a predetermined rate, people would be duped into accepting lower real pay (but greater nominal wages), ensuring that staff were employed and the economy remained at maximum capacity.

What causes stagflation?

Oil Prices:

  • In October 1973, the Organization of Petroleum Exporting Countries (OPEC) declared an embargo on Western nations. This caused the price of oil to spike over the world, rising the cost of commodities and increasing unemployment.
  • Critics of this theory point out that quick oil price spikes such as those seen in the 1970s did not coincide with following periods of inflation or recession.

Economic Policies That Aren’t Working:

  • Another viewpoint believes that inadequate economic policy is the cause of both stagnation and inflation. In an otherwise inflationary climate, stagflation may be induced through strict control of markets, products, and labour.
  • Other theories claim that monetary variables play a role in stagflation.

Stagflation vs. Inflation:

  • The fall of the gold standard, as well as the historical record of lengthy periods of simultaneously declining prices and low unemployment under robust commodity-backed currency regimes, are cited by proponents of monetary theories for stagflation.
  • This would imply that, as has been the case, inflation should be expected to persist during periods of economic stagnation under an unbacked fiat monetary system in place since the 1970s.
  • People just adjust their economic behaviour in response to or anticipation of monetary policy changes, according to these viewpoints. As a result of the expansionary monetary policy, prices in the economy grow without a corresponding decline in unemployment, and unemployment rates may rise or fall depending on actual economic events. This suggests that efforts to strengthen the economy during recessions may simply raise prices without promoting actual economic development.

There are two types of inflation: cost push and demand pull:

  • When the cost of production elements such as labour and materials grow rapidly, the cost of production rises as well. Any attempt to pass on these rising costs to customers is doomed to fail “”Cost push inflation” could lead to “demand annihilation” in severe circumstances.

To combat stagflation in India’s economy, take the following steps:

  • Reduced income and corporate taxes are the most effective policy measures since they reduce labour costs while increasing demand.
  • Similarly, GST should be reduced to keep price hikes to a minimum.
  • More grants-in-aid to state and municipal governments should be authorised by the federal government to encourage them to reduce state and local sales.
  • Pay control: A salary control strategy with government intervention should be implemented to limit wage growth. Limiting compensation increases can help to break the wage inflation cycle and strengthen the economy.
  • Supply-side reforms, such as privatisation and deregulation, can serve to increase aggregate supply and reduce production costs, hence reducing stagflation. The private sector must be pushed to invest more and increase supply through tax policy.
  • Inflation should be the primary macroeconomic objective. Lowering inflation may result in higher unemployment and slower economic growth in the short run. This unemployment might be targeted once the price level is under control.
  • Labor reforms: Frictions in the labour market should be reduced by reducing the time and cost of acquiring information about job prospects. Barriers to entry into a profession or unnecessarily high wages should be eliminated.

Indian scenario:

  • The Reserve Bank of India aspires for a retail inflation rate of 4%.
  • The Reserve Bank of India wants inflation to be within a 2% range of the target rate (4 per cent).
  • As a result, the Reserve Bank of India’s retail inflation “comfort zone” is between 2% and 4% “and 6% of the population.”
  • The current situation in India is termed as “cost push inflation.” Inflation is caused by rising raw material and commodity costs, according to this. As a result, the price of finished goods, transportation, storage, and all other economic operations rise, resulting in inflation.
  • This means that, while demand for products and services has remained stable, the price at which it may be met has increased.

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