GS Paper III

News Excerpt:

The Reserve Bank of India (RBI) has reduced the risk of stagflation to 1%, down from 3% in August.

About the news:

• The latest estimates, incorporating data up to Q2:2023-24, assign a very low probability of only 1% to the risk of stagflation.
• The risk was assessed using two approaches:
• Based on phases of lower economic growth and high inflation.
• Using the "at-risk" frameworks - "Inflation at Risk" and "Growth at Risk" using quantile regression.
• Significant determinants of stagflation risk in India include supply-side shocks such as -
• Spikes in commodity prices.
• Tighter financial conditions.
• Higher domestic currency depreciation.

Potential causes of Stagflation:

• Supply shock:

• Stagflation is typically initiated by a supply shock, such as a disruption in the oil supply or a shortage of essential parts, as seen during the COVID-19 pandemic.
• This shock can impact inflation, employment, and economic growth and can be triggered by disruptions in semiconductor flow, affecting the production of various products, from laptops to cars and appliances. 

• Poor Economic Policies:

• • The confluence of stagnation and inflation results from poorly made economic policy.
  • Harsh regulation of markets, goods, and labour in an otherwise inflationary environment is cited as the possible cause of stagflation.

• Loss of the Gold Standard:

• Other theories point to monetary factors that may also influence stagflation.

Stagflation as a destabilising factor:

• Stagflation, which could destabilise an economy by creating uncertainty, is a major concern for the Reserve Bank of India (RBI) as it maintains price stability and growth.
• Stagflation is a combination of three negatives: slower economic growth, higher unemployment, and higher prices.
• Policy solutions for slow growth tend to worsen inflation and vice versa. That makes stagflation hard to fight.
• Higher commodity prices and the appreciation of the U.S. dollar post-pandemic have raised concerns about stagflation globally.
• Delays in monetary normalisation after the pandemic have also raised concerns about costly stagflation.

Conclusion:

Stagflation has no sure remedy. Economists generally agree that productivity must rise to the point where doing so will spur faster growth without raising prices. As a result, the monetary policy might be tightened to control the inflation part of stagflation. Since it is easier said than done, economic authorities must take proactive measures to avert stagflation.

Prelims PYQ

Q. Economic growth is usually coupled with: (UPSC 2011)

(a) Deflation

(b) Inflation

(c) Stagflation

(d) Hyperinflation