Why high inflation regime is here to stay

Sunday January 19, 2014, New Delhi

Our aspiration to control and bring down inflation has been failing since a long time. Much energy has been spent on the subject and almost everyone is convinced the demon will be contained someday. Meanwhile, world has moved ahead and so did the conventional wisdom on the subject. In the process, a lot has happened that suggest that known economic benchmarks have shifted. The new benchmarks suggest the regime of high inflation is here to stay.

Right after the global economic meltdown in 2008, monetary policies followed across the world were aimed at inducing consumption-led-recovery. Not that the Keynesian theory came into application for the first time but the scale of its use merits serious argument. The fear of recession after the global meltdown prompted most economies to adapt expansionary monetary policy. To save the economy, it was hoped, with enough money in the hands of people, consumption could be induced giving the necessary fillip to demand and growth. As an analogy, it is like opening up of all the gates of dam with a hope to bring rain. Nothing of such sort happened.

Economists should have estimated the impact of such policies, especially if they endured longer. When the financial houses started toppling one after another, rescuing a fragile system became a top priority endeavor. Political affinity to support deficit financed consumption-led-recovery gained momentum across the world because it was easier to implement. It did not require much except creating a political mission that aligns with economic outcomes, which was not difficult given the precarious situation of that time. What started thereafter was a secular asset bubble across the world. It was natural because cheap money available was likely to be thrown at assets. An era of inflation was natural fallout.

The idea of printing more money offered the much-needed liquidity in the system but it was not able to create the necessary long-term sustainability. Because the idea was primarily to induce deficit-financed consumption, it was opposite of productivity-led-recovery where adequate dose of stimulus creates a conducive environment for businesses to expand and grow. A consumption led stimulus program offers little reason for businesses to expand. The idea failed miserably is evident from the fact that in last five years, virtually no additional employment was created anywhere in the world.

Whatever happened in the world in last five years applies to India too. The sustained inflation regime of last five years is as a result of deficit finance policy adapted by the government. However, unlike US and Europe, the cost of capital in India kept growing as a result RBI's efforts to fight inflation. A tighter monetary policy did have the intended impact on the Industrial Growth, which nosedived, but inflation continued to stay brave because of easy money available from elsewhere.

The situation going forward does not look rosy either. The US and Europe desperately need to be come out of the economic mess and the only option they seem to know is creating bubbles to induce consumption. It is unlikely that the ongoing policy is going to be scrapped anytime soon as their economies continue to struggle. On the other hand, India's experiment with its policy of controlling inflation has not yielded results. It cannot let its growth continue to dwindle particularly when the rest of the world is operating from a contrary position. India is highly likely to start focusing more on growth than controlling inflation. To that effect, we can be rest assured that inflation is not going to subsidize anytime soon.

The traditional economic practices of erstwhile years had been about careful steering of the economy in and out of any situation. The results against actions came slow in small doses and therefore operated within very thin margins of error. The neo-liberal economists of today seem to be expecting results too fast. They obviously seem to operate with wider margins of error. We are probably witnessing a paradigm shift in framework within which today's economists operate. May be, the benchmarks we are so used to operate with are not relevant anymore. If the shift is really happening, may be, high inflation is a new reality of the world.

(Samar Vijay is Director, InvestCare, a leading fund management company. You can reach him on twitter @samarvijay)

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