Policymakers face a tricky dilemma as prices in the economy continue to rise even as economic growth has plummeted to well under 5%. Food inflation, now in double-digits, has caused significant pain. The International Monetary Fund on December 23 called for “urgent” policy measures to reverse the current slowdown. The warning is timely given the economy’s precarious state and the government’s lack of urgency to reverse the slowdown.

Inflation with slow growth leads to dilemma

However, what makes the job of policymakers a lot more complicated is the non-uniform nature of the current price rise. Even as food prices have risen rapidly — food inflation has crossed the 10% mark for the first time in many years — sectors such as manufacturing have witnessed mild deflation as demand for products drops.

What is the response of RBI?

The Reserve Bank of India (RBI) Governor, while terming the recent spike in inflation as a transient phenomenon, has called for countercyclical measures and structural reforms to help the economy. The central bank’s hands have been tied down by the recent spike in inflation, and it has halted its rate cut spree that began in February this year.

What is the possible cause of uneven inflation?

Still, what is really behind the wide divergence in inflation rates across various sectors is anyone’s guess. It may well be that the current food price inflation is the result of seasonal factors that have affected crop production. If so, it should certainly be a transient phenomenon that will not trouble policymakers for anything beyond a few quarters. At the same time, it should be noted that various prices in the economy generally do not rise or fall in tandem.

Policymakers, however, tend to view the economy as an entity with a general price level that responds in predictable ways to their policy actions. Such an assumption is likely to cause practical difficulties in implementing policy.

Source: The Hindu

Relevant for GS Prelims & Mains Paper III; Economics