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Wednesday, 05 Oct 2022
By Vivek Kaul

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Inflation, Economic Growth and Ajay Devgn

Sometime in 2012 or perhaps early 2013 I happened to meet a retired governor of the Reserve Bank of India (RBI). This was the time when I had finished working on a draft of what would turn out to be my first three books, and was heavily influenced by the Austrian school of economics.

The Austrian school believes in minimal government intervention in the economy, for the simple reason that a central institution like a government cannot possibly know everything that is happening in the economy and given that, it’s best to let the free market operate on its own and let people and the firms make their own decisions.

As Thomas Sowell writes in Intellectuals and Society: “In market economies, for example, consumers and producers make their own decisions individually and the social consequences are determined by the effect of those individual decisions on the way resources are allocated in the economy as a whole, in response to the movements of prices and incomes—which in turn respond to supply and demand.”


This logic notwithstanding, the modern economy is full of government interventions in various forms, including the governments and central banks of the rich world stepping in to rescue many financial firms which were in trouble, after Lehman Brothers, the fourth largest investment bank on Wall Street at that point, went bust in mid-September 2008.

My question to the retired RBI Governor was that shouldn’t do nothing have been a possible strategy for central banks and governments. Why couldn’t they just have just taken a backseat and let the free market sort things out? The gentleman’s answer to the question was simple: “Do nothing cannot be a strategy.” This was accompanied by a wry smile, on perhaps my naiveness in believing what I did.

Over the years, I have thought a lot about do nothing not being a strategy and have come around to the idea that this was one of the smartest things I have ever been told. In democracies, when a crisis erupts, governments and their institutions need to be seen to be doing something.

Any government which communicates that do nothing is going to be their strategy when a particular crisis erupts, is going to be dubbed as heartless and immediately see a drop in popularity ratings. So, the entire system is structured in a way where governments and their institutions are seen to be doing something.

This explains why governments and its institutions, politicians and bureaucrats, offer immediate solutions for problems that keep erupting from time to time. All solutions have unintended consequences or unseen effects, which are not thought through or not talked about or not talked about enough, when the solution is first offered.

Given this, when the covid pandemic first broke out, it was hardly surprising that governments and central banks across the world reacted immediately and started offering and implementing solutions to the problem.

Of course, given how badly covid had impacted the economy, it was the right thing to do at that point of time. Do nothing couldn’t have been a strategy, when so many people were going through economically, emotionally and a physically difficult time.

In this scenario, an estimate made by The Economist suggests that central banks of the rich world printed money worth $12 trillion in total, to fight the negative economic impact of covid. The idea was to print money and flood it into the financial system.

This would drive down long-term interest rates, helping individuals, corporates and most importantly governments, borrow at low interest rates. With more borrowing and spending, economic activity would pick up.

In fact, the governments across the world, particularly the rich world (the developed economies), increased their spending big time. As a recent report by the World Bank published in mid-September and titled Is a Global Recession Imminent? points out: “In 2020 alone, government spending in advanced economies and emerging market and developing economies increased by more than US$ 4 trillion.”

The governments spent more by borrowing more. The increased borrowing was made possible by central banks printing money and driving down interest rates. As the World Bank report points out: “Globally, government debt registered its biggest single-year jump, to roughly 100 percent of GDP—its highest level in more than half a century.”

Global government debt

Some of this increased borrowing by governments was handed over directly to people. The governments of the rich world put money directly into the bank accounts of people.

So, lower interest rates accompanied by higher government spending, particularly in the form of handing over money directly to people, revived economic activity and the global economy grew by “5.7 percent in 2021—its strongest post-global recession pace in 50 years”. This is what economists call a V-shaped recovery, where the fall is accompanied by a quick rise.

The trouble is this V-shaped recovery is turning out to be unsustainable and is running out of steam. The reason for this lies in the fact that while offering these solutions, the politicians, the economists, the bureaucrats and the analysts, showed us just one side.

Nonetheless, all economic decisions, have another side; the unseen or the unintended consequences of economic decisions, which people in the business of communicating economics rarely seem to talk about.

In order to get a better grasp of these unseen effects, we need to talk about the French economist Frédéric Bastiat who lived through 1801 to 1850. In the year he died, a pamphlet authored by him and titled ‘What is Seen and What is Not Seen,’ was published.

Edward Chancellor talks about this pamphlet in The Price of Time, where he writes: “In ‘What is Seen and What is Not Seen’ Bastiat tells the parable of a merchant, Jacques Bonhomme, whose shop window is broken by his careless son. Neighbours thought that it wasn’t all bad news. At least repairing the window provided employment for the glazier, who could spend the money on food and other sundries. But Jacques Bonhomme now had less money to spend, says Bastiat.”

The neighbours of Jacques Bonhomme saw only the seen effect of his son breaking the window, which led to the glazier getting a job to replace the window, earning money and then spending it. Nonetheless, there is an unseen effect to this as well, which the neighbours did not talk about.

Henry Hazlitt describes this unseen effect in Economics in One Lesson: “But the shopkeeper will be out (of money) that he was planning to spend for a new suit. Because he has had to replace a window, he will have to go without the suit (or some equivalent need or luxury). Instead of having a window and (the money) he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window and no suit.” This is the unseen effect of Bonhomme’s son having broken his window.

In a similar sort of way, all economic decisions have seen and unseen effects. While, the seen effects are usually positive and immediate, hence, tend to get highlighted and talked about, the unseen effects are negative and often take time to play out, and hence, tend to get overlooked. Hazlitt refers to this tendency of looking at “only the immediate effects of a given policy,” as the fallacy of overlooking secondary consequences.

As he writes: “The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences.”

This is precisely how things have played out in the post-covid world. The central banks have been happy to print money and drive down interest rates to almost zero, across large parts of the rich world. The governments have been happy to borrow money at lower interest rates and hand it over directly to people. The people have been happy in spending this money.

All this led to an economic bounce back and a V-shaped recovery. The trouble is that the unseen effects or the secondary consequences of all this are now gradually coming upon us.

In May 2020, the global consumer price inflation or retail inflation was around 2%. By July 2022, this had jumped to 9%, the highest it has been since 1994. As the World Bank report cited earlier points out: “The pickup has been broad-based, occurring in almost all countries for which data is available.”

Global consumer price inflation

How did the world end up with such high retail inflation? The disruption of supply chains in the aftermath of covid created a shortage of products. At the same time, governments of the rich world put money directly in the bank accounts of people, thus creating huge consumer demand. Russia’s attack of Ukraine in February pushed up food and fuel prices.

In fact, the close to zero interest rates led to massive bubbles in stocks, real estate and bonds. The real estate bubble has directly fed into retail inflation, with buying homes becoming expensive, rents have also gone up. Rents are an important constituent of how retail inflation is calculated in the rich world. Hence, high home prices have pushed up home rents, which has in turn pushed up retail inflation.

A major mandate of central banks across the world is to ensure that inflation in their respective economies remains at reasonable levels (usually around 2% in the rich world). The central banks can control inflation by raising interest rates and which is precisely what they are doing.

Along with this, the governments have been cutting down on their expenditure. They clearly can’t continue to spend as much as they did during 2020 and 2021, given that they have already borrowed a lot of money.

As the World Bank report points out: “The growth of global government expenditures is projected to fall sharply from an unprecedented high of 18 percent of global GDP in 2020 to 3 percent in 2022, a level more in line with its 2010-19 average.”

So, globally synchronised higher interest rates along with lower government spending is expected to rein in the decadal high-inflation that prevails almost across the world, and not just the rich world. With lesser money chasing goods and services, consumer demand is expected to come down, and in the process lead to a lower rate of price rise or inflation.

Also, with interest rates going up, the bubbles in different asset classes like stocks, bonds and real estate are losing steam. This will have its own share of repercussions.

Further, as interest rates in the US rise, money from other parts of the world will move to the US, given that the dollar is deemed to be the safest asset in the world. This makes the dollar stronger against other currencies. In fact, that is already happening. When the dollar gets stronger against other currencies, the other currencies lose value or depreciate.

Many commodities, including oil, are bought and sold globally in dollar terms. When the dollar gets stronger against other currencies, these commodities become expensive in local currency terms and that feeds into retail inflation.

What this basically means is that when interest rates in the US rise and the dollar becomes stronger, the US essentially ends up exporting inflation to other parts of the world.

These are the obvious seen effects of rising interest rates. Nonetheless, there is an unseen effect to all this as well, which is that “because these policies are highly synchronous across countries, they could be mutually compounding in their effects—tightening financial conditions and steepening the global growth slowdown more than envisioned.”

In fact, as Jerome Powell, the Chairman of the US Federal Reserve, recently said: “The median forecast now I think this year among my colleagues and me, was 0.2 percent growth. So that's very slow growth.”

The chances are that the US might already be in a recession. Technically, a recession is defined as a scenario where the size of an economy, measured by its gross domestic product (GDP), contracts for two consecutive quarters.

As the World Bank report points out: “US GDP is estimated to have contracted at an annualized rate of 0.9 percent in the second quarter of 2022, the second consecutive quarter of negative growth…All previous global recessions coincided with recessions in the United States.”

If one were to state this in simpler words, the central banks and governments can’t drive down decadal high inflation and push up economic growth, at the same time. Trying to meet both the goals at the same time, is like a single person riding two bikes, like Ajay Devgn did in his debut film Phool Aur Kante.

While Devgn’s ride was very smooth on a Mumbai road without any potholes, any central bank trying to push up growth and control inflation at the same time, is bound to hit a pothole at some point of time. In the end, we go back to the cliché that what works in reel life doesn’t necessarily work in real life.

To conclude, this is not to say that central banks and governments shouldn’t have done what they did in the aftermath of covid. But at the same time, it was important to communicate about the possible unseen effects of the actions that they were taking.

There was next to no communication along these lines. In fact, the rich world central bankers kept talking about a soft landing as late as the start of this year.

They were telling the world at large that they will be able to manage any inflation that comes their way and ensure that their respective economies also keep growing at a reasonably fast pace. But that hasn’t turned out to be true. What Ajay Devgn could possibly do more than three decades back, the central bankers can’t do now.

While one can understand politicians only highlighting the positive part of the decisions they had made, one did expect central bankers to be more honest about what was happening.

Sadly, that did not happen. Raghuram Rajan summarized this situation best when he told The Economist in April: “The “hubris” of central bankers… lies in thinking they can solve all problems.”

Or as the average person reacts when one talks about problems, “don’t tell us about the problems, give us the solution”. Well, the thing is, just because every question asked in your school or college exam had a solution, or just because many so-called experts out there are mouthing confident sounding solutions for almost every problem, doesn’t mean that every problem in an economy has a solution.

Exam life and expert life is different from real life. Sometimes there are no solutions and one has to sit and bear things out. The global economy might just be entering a phase like that.

Typically, when economies slowdown, central banks cut interest rates and try to pump economic growth by getting people and firms to borrow and spend more. Governments also try to spend more. But this time around, the central banks also have massive inflation to deal with. So, they can either control inflation or they can drive growth. They can’t possibly do a Devgn.

PS: This might be a good time to discuss the Betteridge's law of headlines, which states that any piece with a headline ending with a question mark, can be answered with a “no”. So, in the above newsletter I have cited a World Bank report titled Is a Global Recession Imminent? Following Betteridge’s law we can answer with the word “no”.

The interesting thing is that the report while having the word recession in its headline does not forecast one. It develops two economic scenarios. If the world were to go through a sharp downturn, which is one the scenarios, the report states that the global economy will experience a pronounced reduction in growth.

A pronounced reduction in growth as per the report means that “in per capita terms, global growth would slow to 0.8 percent in 2023—its slowest rate since 2008 (excluding the 2009 and 2020 global recessions).”

The point being that it’s not just journalists who seem to be practicing the Betteridge’s law of headlines. Sensationalism sells. Clickbait zindabad!


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Written by Vivek Kaul. Edited by Saikat Chatterjee. Produced by Nirmalya Dutta. Send in your feedback to

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