Stagflation

STAGFLATION Stagflation is a term referring to transitional periods when the economy is simultaneously experiencing the twin evils of Inflation and high Unemployment, a condition many economists as late as the 1950s considered a typical of the U.S. economy. Stagflation occurs when the economy is moving from an inflationary period (increasing prices, but low unemployment) to a recessionary one (decreasing or stagnant prices and increasing unemployment). It is caused by an overheated economy. In periods of moderate inflation, the usual reaction of business is to increase production to capture the benefits of the higher prices. But if the economy becomes overheated so that price increases are unusually large and are the result of increases in wages and/or the costs of machinery, credit, or natural resources, the reaction of business firms is to produce less and charge higher prices. The term first came into use in the mid-1970s, when inflation soared to 12 percent and the unemployment rate nearly doubled to 9 percent. This inflation was the result of the quadrupling of oil prices by the Organization of Petroleum Exporting Countries (OPEC), increases in the price of raw materials, and the lifting of Vietnam-era governmentimposed Price and Wage Controls. At the same time, the economy went into recession. In 1979 the high inflation rate was sent spiraling upward when OPEC doubled petroleum prices after the Iranian revolution. President Jimmy Carter established the Council on Wage and Price Stability, which sought voluntary cooperation from workers and manufacturers to hold down wage and price increases. The council could not control OPEC, however, and repeated oil-price hikes thwarted the council's efforts. Years of continued inflation and high unemployment was one of the factors that undermined the Carter presidency and Democratic Party proposals for welfare reform, national health insurance, and reform of labor law. In 1980, after years of double-digit inflation the Federal Reserve Board (Fed), under Paul Volcker, prodded banks to raise interest rates to record levels of more than 20 percent to induce a recession and break the inflation cycle. Subsequently the Fed pursued a monetary policy designed to head off significant increases in inflation, but in 1994–1995, seven Fed increases in short-term interest rates failed to moderate economic growth. This led to speculation that in a global economy, domestic monetary policy may not be as effective in controlling stagflation as previously thought. This term was widely used in the 1970s to describe the co-existence of stagnant economic growth and high inflation. If we revisit the wonder years of 1970s, when the economy was over regulated, oil shocks had the ability to paralyze the nation and the central bankers still thought there was a trade off between growth and inflation. In 1960s economists Milton and Edmund Phelps challenged the idea of permanent trade off between unemployment and inflation, the experience of the 1970s would seem to bear them out as the inflation had reach double digits and the unemployment had reached 9%. The world economy has had several good years, global growth has been strong, and the divided between the developing countries and developed world has narrowed, with India and China leading the way, even Africa has been doing well, with growth in excess of 5% in 2007. But the good times are ending. There have been worries for years about the global imbalance; America’s ill- conceived war in Iraq helped fuel to quadrupling of oil price

since 2003. in the 1970s, oil shocks lead to inflation in some countries and to recession elsewhere, as governments raised interest rates to combat rising prices and some economies faced the worst of both worlds; stagflation. The administration now is hoping, somehow, to forestall a wave foreclosure- thereby passing the economy’s problems on to the next president, just as it is doing with Iraq quagmire. Their chances of succeeding are slim. For America today, the real question is only whether there will by be short, sharp down turn, or a more prolonged, but shallower, slowdown. Moreover, America has been exporting its problems abroad, through the everweaking dollar, for instance Europe; for instance, will find it increasingly difficult to export and in the world economy that had rested on the foundations of a strong dollar the consequent financial market instability will be costly for all. At the time, there has been a massive global redistribution of income from oil importers to oil exporters- a disproportionate number of which are undemocratic states and form workers everywhere to the very rich. It is not clear whether workers everywhere will continue to accept decline in their living standards in the name of an unbalanced globalization whose promises seem ever more elusive. Indeed, the flip side of ‘a world awash with liquidity’ is a world facing depressed aggregate demand. There is one positive note in this dismal picture; the sources of global growth today are more diverse than they were a decade ago. The real engines of global growth in recent years have been developing countries. Nevertheless, slower growth – or possibly a recession – in the world’s largest economy inevitably has global consequences. There will be a global slowdown. If monetary authorities respond appropriately to growing inflationary pressure – recognizing that much of it is imported, and not a result of excess domestic demand – we may be able to manage our way through it. But if they raise interest rates relentlessly to meet inflation targets, we should prepare for the worst: another episode of stagflation. If the central banks go down this path, they will no doubt eventually succeed in wringing inflation out of the system.

INFLATION The rate of growth improved in the 1980s. From fiscal year 1980 to 1989, the economy grew at an annual rate of 5.5 %, or 3.3% on a per capita basis. Industry grew at an annual rate of 6.6% and agriculture at a rate of 3.6%. A high rate of investment was a major factor in improved economic growth. Investment went about 19% of GDP in the early 1970s to nearly 25 % in the early 1980s. India, however, required a higher rate of investment to attain comparable economic growth than did most other low income developing countries. Private saving financed most of India’s investment, but by the mid 1980s further growth in private savings was difficult because they were already at quite a high level. As a result, during the late 1980s India relied increasingly on borrowing from foreign sources. This trend led to balance of payments crisis in 1990; in order to receive new loans, the government had no choice but to agree to further measures of economic liberalization. This commitment to economic reform was reaffirmed by the government that came to power in June 1991.

The 1990s is widely described in general as a price stability era all over the globe. During the early part of the decade developed and developing countries alike experienced a distinct ebbing of inflation. India started having balance of payment problem since 1985, and by the end of 1990, it found itself in serious economic trouble. The government was close to default and its foreign exchange reserves had dried up to the point that India faced high inflation and large government budget deficits. The Indian economy has been registering a mammoth GDP growth post liberalization. The opening up of the Indian economy after the 1990s increased India’s industrial output, which in turn raised the inflation rate significantly. The growth rate of industrial output and employment created an enormous pressure on the inflation rate and pushed it further. The RBI and the Ministry of Finance, government of India is concerned about the present upswing of inflation in India. The main cause of rise in the rate of inflation India is the pricing disparity of agricultural products between the producer and consumer in the Indian market. More ever, the sky rocketing of prices of food products, manufacturing products, and essential commodities have also catapulted the inflation rate in India. Furthermore, the unstable international crude oil prices have worsened the situation. The RBI has assured the Indian business community and the general public about the harmless rise in the CRR but apprehensions still amongst business circles in India. The RBI is devising methods and financial models to arrest the rise in the rate of inflation in India. The RBI had given top priority to price stability and economic growth sustenance in India, in its recently drafted monetary policy. The RBI of India has rise the cash reserve ratio in a continuous manner to arrest the rise in the rate of inflation India. India has to not only ensure inflation stabilization but also sustain the present economic growth rate.