INFLATION in the USA and INDIA

  • May 9, 2022
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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INFLATION in the USA and INDIA

Subject: Economy

Section: Monetary policy

Context:

Last week, within hours of each other, central banks in India and the US raised interest rates and signaled a tighter monetary policy in a bid to contain rising inflation. However the move is expected to hurt the Indian economy far more than the US economy.

Cause of divergence Divergence:

  1. Divergence in growth
  • The US economy is roughly ten times the size of the Indian economy and in terms of per capita income it is more than 30 times than that of Indian economy
  • India’s economic growth had been steadily losing its growth momentum since October 2016.Contrast to this the US was enjoying the longest expansion (over 10 years) in its economic history.
  • India has barely managed to get back to the same level of GDP that it had before the Covid pandemic, the US is one of those rare cases, where the recovery has been so sharp that the economy has barely lost a step. 
  1. Divergence in inflation:
  • In India, inflation was much higher than the RBI’s target (4%) long before the Covid-induced nationwide lockdowns were announced in March-end. Contrast this with the US inflation, which stayed well within the US Fed’s target of 2% right up to the first couple of months in 2021.
  • In the US, inflation has now hit a four-decade high while in India the situation is still not as alarming.
  • The US Inflation is due to the demand pull and growth recovery while India facing cost push inflation amidst deficit demand
  1. Dependence on import-India’s much greater vulnerability because the country is dependent on imports for 80% of its total fuel needs.
  2. Status of employment

In India, unemployment had been the highest in the past almost 45 to 50 years even before the pandemic. Contrast this with the situation in the US-the unemployment rate in the US is at a five-decade low wages are rising due to demand>supply of labour leading to wage price spiral

Impact of rising interest rate:

Typically, a tighter monetary policy (that is, higher interest rates and reduced money supply) dampens overall demand and reduces inflation. However, containing inflation comes at the cost of reduced economic growth and higher unemployment.

  • India-
    • Less impact of reducing inflation as cost push nature of price rise
    • Further aggravate unemployment causing stagflation
  • USA
    • Reduce wage price spiral by reducing demand of labour and wages
    • Reduce inflation as inflation is demand pull type
The wage-price spiral is a macroeconomic theory used to explain the cause-and-effect relationship between rising wages and rising prices, or inflation.

The wage-price spiral suggests that rising wages increase disposable income raising the demand for goods and causing prices to rise. Rising prices increase demand for higher wages, which leads to higher production costs and further upward pressure on prices creating a conceptual spiral.

Causes of inflation

1.Demand Pull Inflation-

Where, AD- aggregate demand GPL-general price level and Real GDP- aggregate supply

Factors leading demand pull inflation-

Increase in public expenditure, increase in money supply, increase in demand for consumer goods and capital goods.

2.Cost Push Inflation-

Various causes of cost push inflation in India-erratic agriculture growth, hoarding of essential commodities, inadequate industrial production, administered prices, recent supply chain disruption due to covid19 and rise in crude oil pricesetc..

economy INFLATION in the USA and INDIA