Stagflation

Stagflation

Subject – Economy

Context – Dr Amit Mitra, a seasoned economist-turned-politician and Principal Chief Advisor (Cabinet rank) to the Chief Minister and Finance Department, Government of West Bengal, feels that “there is no readymade formula to tackle stagflation which is policy-induced

Concept –

• It is a seemingly contradictory condition described by slow economic growth and relatively high unemployment, or economic stagnation, which is at the same time accompanied by rising prices (i.e. inflation).
• Stagflation can also be alternatively defined as a period of inflation combined with a decline in gross domestic product (GDP).
• Typically, inflation rises when the economy is growing fast. That’s because people are earning more and more money and are capable of paying higher prices for the same quantity of goods.
• When the economy stalls, inflation tends to dip as well – again because there is less money now chasing the same quantity of goods.

Steps needed to control stagflation in Indian economy:

Tax measures: The best policy measure is to reduce income tax and corporate taxes as they tend to reduce labour costs and raise demand for labour. Similarly, GST should be reduced in order to prevent the price level from rising. To encourage state and local governments to reduce state and local sales, the central government should sanction additional grants-in-aid to them.

Wage control: A policy of wage control should be adopted with government intervention to limit wage rises. When wages rise, firms are forced to reduce production and employment. Consequently, there is a fall in real income and consumer expenditure. Limiting wage increases can break the cycle of wage inflation and help to improve the economic situation.

Supply-side solutions: One solution to stagflation is to increase aggregate supply through supply-side policies, for example, privatisation and deregulation to increase efficiency and reduce costs of production. Private sector must be incentivised to invest more and to increase supply through tax measures.

Monetary policy: The primary macroeconomic objective should be to reduce inflation. Reducing inflation may cause higher unemployment and lower economic growth in the short-term. But, this unemployment can be targeted once the price level is controlled.

Labour reforms: Frictions in the labour market should be reduced by reducing the time and cost involved in obtaining information about employment opportunities. Barriers which either limit entry into a profession or maintain wages at artificially high rates should be removed.