Home / Opinion / Columns /  We’re on a knife’s edge between global reflation and stagflation
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The pandemic is a unique economic event from the point of view of today’s globalized world. Supply and demand consequences of the event itself and actions taken in response resemble other periods in history, but are without parallel in totality.

This has left us with many questions. Such as: 1) Will inflation be temporary or permanent; 2) Will stimulus-driven demand settle down; 3) How soon will supply chains normalize; and 4) Will there be more virus-induced economic shocks to follow?

First, the full background. As the pandemic spread around the world, demand cratered both from fear and lockdowns. Services, travel, tourism, and retail operations took the hardest hits. Furloughs and layoffs of employees followed, which decreased disposable income and contributed further to plummeting demand. Central banks around the world responded with massive liquidity and monetary support while governments piled on unprecedented fiscal spending. The US Federal Reserve balance sheet, which had risen from about $1 trillion to $4 trillion over a 10-year period after the global financial crisis (GFC), doubled to $8 trillion within a single year. The US fiscal deficit will top 10% of its gross domestic product (GDP) this year, the largest since World War II; US federal debt in now nearly 130% of GDP (2021), which is higher than its World War II peak of 120%. Developed economies around the world have each added 8-10% of GDP in terms of fiscal stimulus, preferring strong and quick intervention over a wait-and-see approach of the kind they had adopted after the GFC.

In the early months of the covid pandemic, firms around the world reacted with a swift reduction in capacity. For instance, major rental car operators in the US sold more than 750,000 cars in fleet shrinkage efforts, planes were grounded, ships berthed and shipping containers left stranded far inland. As demand recovered, this created massive supply bottlenecks, resulting in rising prices. The whipsaw in demand caused by successive waves of the pandemic only made matters worse. The increase in prices across various goods and services is now among the broadest the world has seen since the 1970s. From oil prices and food staples to semi-conductors and cars, prices have risen sharply. Oil prices have risen by around 40% and food prices (led by cereals, dairy, and sugar) in aggregate by 27%, year-on-year. The latest annual inflation rate in the US is 6.2% and between 4% and 5% in the UK, Germany, Canada and India.

The received wisdom in recent months has been that this inflation is “transitory" and will quieten down once supply chains normalize and rebound consumption settles. Central banks, particularly in developed markets, are likely first to taper bond purchases and raise policy rates only gradually after that, perhaps beginning as late as in 2023. European Central Bank President Christine Lagarde reiterated that “conditions to raise rates are very unlikely to be satisfied next year". The recently-reappointed Federal Reserve Chairman Jerome Powell has signalled a possible advance in scaling back the Fed’s bond purchases, but remains relatively sanguine about US inflation coming down in the second half of next year. Reserve Bank of India Governor Shaktikanta Das has telegraphed the central bank’s worries, but appears ready to accept retail inflation at the higher end of the 2-6% range enshrined in the Monetary Policy Committee (MPC) mandate.

The world has been through an unconventional decade of monetary stimulus to save economies from the threat of deflation. Despite this, there was only one year of synchronized global growth in 2017 during the entire decade before the pandemic struck. To this extraordinary monetary stimulus, we have added a significant fiscal stimulus in the aftermath of the covid outbreak. At the same time, populist politics around the world has necessitated that economic policy be more focused on broader social goals, including universal healthcare, inequality reduction and climate-change mitigation.

Even though political priorities have shifted, central bankers must remain vigilant on inflation. Sustained inflation disproportionately impacts the poor and vulnerable in any society, and so even populist politicians will have to contend with its ill-effects. Inflation may accomplish, politically, what weak oppositions appear unable to do at the polls. Equally, demand-led growth must prioritize investment over consumption. Otherwise, we risk stagflation, a rare but worrisome phenomenon of high inflation with low growth. The fiscal response to the pandemic historically ‘rhymes’ with the war-time spending of the 1940s and post-war reconstruction. Given the period’s focus on investment, that phase of ‘reflation’ ended like good cholesterol, encouraging good growth at modest inflation around the world in the 1950s.

For India and emerging markets, this environment is an opportunity as well as a challenge. As one of the world’s fastest growing economies, India will continue to attract capital in a world of low interest rates, thus stabilizing its currency, current account and macro-economy. This capital can help build on the economic gains of a vibrant startup sector that Indian entrepreneurs have shown a great propensity for. At the same time, without significant reforms in factor markets and material improvements in supply chains and logistics, rising demand will only add to India’s inflationary pressures. To prevent the bad cholesterol effect, Indian policymakers must accelerate reforms and prioritize investment over consumption while staying ever vigilant on inflation.

P.S: “The lesson is clear, inflation devalues us all," said Margaret Thatcher.

Narayan Ramachandran is chairman, InKlude Labs. Read Narayan’s Mint columns at

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