Stagflation Risk Assessment by RBI

Stagflation Risk Assessment by RBI

Subject : Economy

Section: National Income

• Stagflation Risk Reduction: Officials at the Reserve Bank of India (RBI) have revised down the risk of stagflation, a combination of economic stagnation and high inflation, from 3% in August to 1% based on recent data.
• Methodology Used: The assessment involved two approaches. The first considered phases of low economic growth coinciding with high inflation.

The second employed “Inflation at Risk” (IaR) and “Growth at Risk” (GaR) frameworks, using quantile regression to gauge the likelihood of stagflation.

• Determinants of Stagflation Risk: According to the RBI, empirical findings indicate that supply-side shocks, such as spikes in commodity prices, along with tighter financial conditions and a relatively higher depreciation of the domestic currency, are major determinants of stagflation risk in India.
• Historical Context: Elevated risks of stagflation were observed during specific episodes, including the Asian Crisis, the Global Financial Crisis, the taper tantrum, and the COVID-19 pandemic.
• Concerns Raised: Stagflation is viewed as a destabilizing factor with the potential to disrupt the entire macroeconomic framework by creating an environment of uncertainty. The RBI considers it a major concern, given its mandate to maintain price stability while considering the objective of growth.
• Global Stagflation Concerns:Higher commodity prices and the appreciation of the U.S. dollar post-pandemic have raised concerns about stagflation globally. Delays in the monetary normalization process after the pandemic also contribute to worries about potential costly stagflation.
• Weak Passthrough of Crude Oil Prices: The weak passthrough of crude oil prices to domestic petrol and diesel prices limits the predictive power for stagflation, according to the RBI.
• Central Bank Focus: The focus of central banks on maintaining price stability and ensuring the financial health of institutions has helped anchor long-term inflation expectations to the inflation target, unlike the 1970s when expectations were weakly anchored and reached exorbitantly high levels.

Inflation in India

Inflation: Inflation refers to the general increase in prices and the fall in the purchasing power of money. It occurs when the demand for goods and services surpasses their supply, leading to an increase in their prices. High inflation can erode the value of savings and income, leading to reduced consumer spending and economic instability.

Types of inflation include:

• Demand-pull inflation: Caused by increased consumer demand that outpaces supply.
• Cost-push inflation: Caused by an increase in production costs, such as wages or raw materials, leading to higher prices.

Deflation: Deflation is the opposite of inflation and refers to a sustained decrease in the general price level of goods and services. It occurs when the supply of goods exceeds demand, leading to reduced prices. Deflation can discourage spending, as consumers may delay purchases in anticipation of lower prices, which can further slow down economic growth and potentially lead to recession.

Stagflation: Stagflation is a situation characterized by a combination of stagnant economic growth, high unemployment, and high inflation. It presents a challenge for policymakers, as traditional measures to stimulate economic growth, such as increasing the money supply, may exacerbate inflation.

Hyperinflation: Hyperinflation is an extremely high and typically accelerating inflation. It occurs when the price levels rise rapidly, eroding the value of the currency. This phenomenon often results from a collapse in the currency and is detrimental to the economy, leading to a loss of confidence in the currency and undermining economic stability.

Reflation: Reflation is an attempt to stimulate an economy that is experiencing deflation. It involves the implementation of monetary or fiscal policies to increase the money supply and boost aggregate demand, with the aim of reversing deflation and stabilizing prices.

Disinflation refers to a slowdown in the rate of inflation. While prices may still be rising, they are doing so at a slower pace compared to the previous period. Disinflation does not imply a decrease in prices, as is the case with deflation, but rather a reduction in the rate of increase of the general price level in an economy. Disinflation can occur for various reasons, such as increased productivity, reduced consumer demand, or a drop in the prices of commodities.