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High consumer and wholesale price inflation numbers amid low/no growth have made matters interminably worse for India’s economy. Note: We are now in a red alert zone on stagflation.

A temporal rise in inflation is bound to occur as decentralized lockdown curbs are eased, given that economic agents (say, firms or households) would act by their own devices to decide what, where and how much to spend, without taking into consideration whether sufficient supply of a given product or service is available.

After weeks of lockdown in April and May, if people want to get a haircut at a saloon, for example, its price would depend on how many saloon owners have their shops open and how many hair-dressers are back at work. These factors do not work in tandem. It may take time for saloon owners to open up while ensuring covid protocols are in place so that consumers feel safe. They would operate on low capacity (taking fewer appointments), and most hair stylists may be reluctant to work or demand higher wages for their risk of exposure to infection. These factors could push up the general price of a haircut (or other saloon services).

Similarly, in an informal space, if a chai-waala operating near a construction site in Delhi sees a surge in demand for tea after unlocking, he would immediately need a greater quantity of milk from his regular distributor. If the source of this milk happens to be a dairy operation in a state that still has covid restrictions in place, then milk supplies could be disrupted or delayed. In such a scenario, the price of tea would go up.

Interpreting such micro-level observations, I had forecast a rise in the consumer price index back in May, which is now materializing. An interplay of localized factors has coalesced with a high degree of uncertainty in the lives and livelihoods of various economic agents across India, and this is likely to keep inflation on an incline. It is extremely hard to take a formulaic approach to address such a rise in inflationary expectations. Monetary policy may be ineffective.

The Reserve Bank of India and most other central banks of emerging economies are finding themselves helpless in addressing their core objective of inflation containment because the factors behind local inflation are no longer explained by the causal binaries of demand-pull and/or cost-push alone (which are relevant in normal times).

Novel behavioural causes, such as pandemic-driven anxiety, rising uncertainty among consumers and capital scarcity among producers, accentuate the need to use entwined fiscal-monetary support measures that would allow consumer and producer sentiment to improve, which holds the key to getting India’s economy out of the ‘Keynesian tailspin’ it is in.

On the fiscal front, what is required at this point is the provision of greater direct income support through unconditional cash transfers to households, giving them the means to spend. This would help drive both private investment and employment. It is important to state that at this stage, targeted support programmes are less likely to be effective.

Unconditional cash support would expand the capacity of all households to make discretionary expenditures. Any substitutive support in the form of rations, food stamps, or other transfers in kind, won’t help. Even an increased allocation for our rural employment scheme would pay only those who work, and that too, on the assumption that there is work in those areas.

At a time when infections are rising in rural areas and mutant variants of the virus are infecting unvaccinated groups, little rural employment guarantee work may be available, or worse, people may be too afraid to leave home and go work. Conditional cash transfers in such times are less effective.

Therefore, it is critical to think creatively and design localized fiscal interventions to support monetary policy thinking. But I am not sure if most macroeconomists—including those in the Indian economic policymaking spectrum—recognize these micro-level subtleties.

The other problem concerns how most central banks still tend to function under an operative and functional framework that shadows the work of Milton Friedman. We are already seeing evidence of how monetary policy design and central bank autonomy are becoming an institutionalized myth across nations. Keynes’ biographer Robert Skidelsky has pointed out how a reluctance to admit the relevance of Keynesian theory over monetarism has warped the language of macroeconomic policy (bit.ly/2UpBn5D).

In India, we have seen the central bank bear much of the responsibility of holding out lifelines. Its recent quantitative easing of liquidity in response to the covid-induced economic crisis was a veiled attempt by the government to have monetary methods used as a substitute for direct fiscal intervention.

Going forward, the key to framing a comprehensive response to inflationary tensions would be to pursue a localized and counter-cyclical fiscal-monetary approach that combines the instruments of direct government support with easy liquidity and bank credit provisions, so that economic agents have a wider set of choices.

A monolithic macro approach to address a temporal rise in inflation, or effort to fix supply disruptions solely through a monetary policy tool-kit, is likely to prove ineffective. It could even drive other aggregates like consumption and private investment demand into deeper recession.

Deepanshu Mohan is associate professor of economics at OP Jindal Global University

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