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“Inflation is taxation without legislation”. 

Milton Friedman

Rising prices or inflation, is an undesirable and unwarranted phenomena. India’s inflationary discourse before and since the onset of the pandemic has been volatile. Shocks from all sides, albeit domestic, demand & supply, international or COVID, all have played an essential role in shaping India’s macros. This period was also a test for insulation against these shocks and laid the need for introspection. Monetary authorities have swayed between output and inflationary target grounds along the discourse.

 In January 2020, Inflation reached a tacit high of 7%. This was the month where protests and other social responses pertaining to the CAA(Citizenship Amendment Act) bill and related elements were actively manifesting. Food inflation during the same period breached 15%. The central bank of India (Reserve Bank of India (RBI)), maintained an accommodative stance in the quest for output revival, wherein the repurchase (repo) rate stood at 5.15%. During this period, the fiscal deficit had touched 9.2%. 

During the course of the pandemic and the subsequent quarters, the RBI maintained an “accommodative” stance keeping the repo rate unchanged at 4% respectively. Economic growth has been extremely volatile during this path, whereas inflation fluctuated around the tolerance band. In May 2020, the government announced a fiscal package of Rs 29.87 lakh crores as part of the “atma nirbharta” initiative. These were periods of increased fiscal outlay and loosened monetary policy, ultimately in the quest for economic revival. Considering the typical central bank’s loss function, the RBI put more weight on output management. A loosened policy stance was consistent up till Q2 of 2022, wherein effects of the Russian invasion of Ukraine, and disruption of global economic order, zero covid-policy in China, embargoes on essentials in southeast Asia started impacting India’s macros. Headline inflation in India peaked to over 7%, and food inflation upticked to almost 15%. Seeing this, the central bank changed its stance to being hard-nosed and inflation averse, the repo rate was increased to 4.9% and then subsequently to 5.4% in Q3 of 2022. Now the composition of inflation as to how much of it is from the supply side and how much is from the previous monetary stance is a matter of investigation. Let’s take a relative approach towards forming a conclusion on the same. 

The US Labor Department, in Feb 2022, reported CPI at 7.5%, which was an all-time high since February 1982. In July 2022, inflation surged to an all-time high of 9.1%. It was reported that people on the lower economic strata of the society, for instance, the Blacks and Hispanics, have been exceptionally and disproportionately hit hard as a major chunk of their expenditure is on essentials ranging from transportation to food. Similar stories pertaining to high levels of inflation were reported by major developed economies. It is important to note inflationary pressures were luminous before the war and global supply chain disruption. It is now quite persuasive to assess the role of fiscal stimulus and monetary policymaking as being the building blocks of inflation or at least partially contributing towards it. In the immediate aftermath of the COVID pandemic slowdown, the demand for physical goods soared, and lately, the demand has shifted to luxury and non-necessity goods and services. 

During the pandemic, the US monetary authority, the FED and the government enacted multiple policies providing fiscal and monetary stimulus. The actions by FED included classic interest rate cuts, open market operations and regulatory charges. On the fiscal side, five stimulus packages were announced at different times, and there were further supplementary measures and relief extensions, both by the Trump and Biden administration. The packages were released as an aid on many different fronts ranging from COVID aid CARES Act to the “American Rescue Plan”. In totality, the stimulus amounts to almost USD 5 trillion. No doubt, there is mounting evidence to consolidate that the stimulus was beneficial and prudent for the US economy, which prevented a recession during and after the COVID quarters. 

Assessing the stimulus and inflation parallels of many advanced economies, similar drawings can be found. A recent study by the federal reserve highlights the role of demand and supply elasticities along with the role of mobility. The cross-sectional study provides interesting insights into factors underpinning inflation and supply-side constraints. The study posits on the basis of regression analysis that the US has registered the maximum impact of domestic stimulus leading to excess inflation, the same phenomena has also been significantly observed in nations which have strong trade links with the US, say Canada. Fiscal stimulus and monetary loosening were executed in periods of low mobility, essentially during lockdowns and other mobility restrictions. This made the supply inelastic to any form of positive pushes, whereas consumer demand was elastic and immediately picked up. This translates to inflation, both in the medium and the long run. 

Based on the same hypothesis, it was found that for countries with very low fiscal stimulus, like India, are not experiencing stimulus-induced inflation, instead “imported inflation” is widespread and was highlighted multiple times by the RBI governor as well. What seems to be the notion is that India has had a fairly calibrated fiscal stimulus, which has a menial role in terms of translation to inflation. The inflation experienced post-war in Europe is seemingly a globalised phenomenon and due to jolts in supply chain systems along with Brent crude movements. The RBI’s aggressive monetary policy is an answer for the same. 

Regardless of the source, inflation is not good. It has menu costs, welfare costs, acts as a tax, reduces purchasing power, consumer confidence is weakened and so on. Stagflation and shrinkflation are rather more applicable to the current times. The RBI and most other central banks have maintained hard-nosed positions, anchoring for inflation and making significant policy rate hikes. The subsequent ease-off on inflation is gradual and slow, but it’s registered. While most economies brace for a recession in 2022-23, both the government and the RBI are assured of recession-proof macroeconomic dynamics. 

Henceforth, with a simple primary assessment of repo rates and macroeconomic policy transitions in other countries, price rises or, rather, inflation can be attested with globalised phenomena rather than domestic pressures. A more refined econometric analysis would be a plausible measure to draw more concrete conclusions. Inflation can be said to be independent of any monetary phenomena at least in the short run and in lieu with relative analysis undertaken. 


Manish Vaidya is Research Intern, CPPR.

Views expressed by the author are personal and need not reflect or represent the views of the Centre for Public Policy Research.

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