Some studies
indicate a possibility of high inflation even in the excess of 10% within the
next year. The expected inflation as per the surveys seem to point towards a
jump of 3-4%. Interestingly, there is a divide among the economists over the
after-effects of the Wuhan pandemic. The world having locked down for more than
a month has without doubt created economic disruption both through Aggregate
Demand (AD) and Aggregate Supply (AS) There has been an induced halt to
aggregate demand with a similar restriction on aggregate supply. Furthermore,
even with the lifting of lockdown, the propensity to self-protect might make
prospective consumers wary of shopping thus lower AD. At the same time, the
reluctance of the workers given the risks associated with the job tasks might
make them skip from work thus adding to constraints in AS. Therefore an
analysis would be worth pursuing over the likely inflationary impact or
otherwise of the economic shutdown caused by the Wuhan flu.
There is a school
of thought that believes that the impact of the Chinese virus is deflationary.
Deflation is contraction of the output, the outcome being falling prices. There
is certainly a case for the same. The consumers are unlikely to spend heavily
on consumption for some time to come. They are likely to reduce discretionary
spending especially on what they perceive to be non-essential goods. This might
hold well if there is widespread feeling that the salaries are uncertain. Further,
in the current context, there is good possibility of many using their savings
to factor in the possible salary losses. The business too is perhaps forced to
cut down its expenditure and dip into its savings. Therefore the pick-up in
consumption is likely to be slow. There are already accumulated inventories
which need to be disposed of. Until the inventories are sold, fresh production
will remain tentative. With most major consumption markets in the red zone,
there is likely to less incentive for the firms to produce hence the fears of
deflation become more real. The talk of U-shaped recovery are those who are
likely to be subscribing to the deflationary school of thought.
Yet there is a
converse to the story. Inflation arises of two reasons. The first is the demand
pull inflation. In this case, the AD increases faster relative to AS thus a
shortage ensues. This will drive up the prices causing demand pull inflation. This
is accentuated when there is excess money supply and government makes no effort
to reduce the money supply. In the current environment, the salaries being
uncertain have eaten into the people’s savings. The government has eased the
money supply with the RBI’s monetary policy being currently aimed at monetary
expansion. Helicopter money is making its appearance in many parts of the
world. The business and households are dependent on the fiscal and monetary
stimulus that could throw the fiscal deficit off balance. The fiscal deficit
thrown off balance makes government borrow money increasing the interest rates
or alternatively print more money creating possible inflationary impacts. The
increase in money supply might induce people to buy more but underproduction or
the inability of producers to keep up with the rising AD might generate
inflationary pressures. The expected V shaped curve might see a demand for AD
but no corresponding increase in the same pace from AS.
Aside of demand
pull inflation which is unlikely, there is an element of cost push inflation. The
government might induce helicopter money to increase the money supply thus an
inducement for AD. Yet the firms face hurdles in production. There is a question
of employees turning up for job. The self-propensity to protect would be
visible among employees too. If there is any incidence of a case in the factory
or the floor, the impact could be severe with many employees abandoning the
floor. The need to accommodate additional risk would entail extra wages. The workers
would demand additional wages thus increasing the costs of production. Further given
the migration back to their home towns, there would in all probability a
shortage of labour adding to the production woes. The need to incorporate additional
safety measures imply the firms have to spend more. All these reflect in the
increased costs of production thus higher prices being passed to the consumers.
There is an
intense competition thus a price war among many players. The consumers desire
lower prices and perhaps reflect a lower marginal propensity to consume apart
from demonstrating increased sensitivity to prices. An option out of this would
be for the firms to pass lower prices to consumers thus taking a hit in profit margins.
This leaves them with less capital for reemployment and reinvestment.
The pandemic
induced global economic crisis is unprecedented. There are very few instances
of global economy being impacted by a pandemic. The last time would have been
the 1918-21 Spanish flu. There are little records on the economic impact and
the inflationary tendencies attributed purely to the pandemic. The world had just
come out of the World War –I. Most of the Europe had been bruised and nearly
destroyed. Russia was emerging out the aftermath of the revolution. Germany was
reeling under aftereffects of the Treaty of Versailles. Asian and African
countries remained the colonies of the European powers. Therefore it is
difficult to attribute the economic impact to the Spanish flu though within the
decade the world was experiencing the Great Depression.
The current
backdrop is of uncertainty. Unlike risk uncertainty management is about getting
subjective probabilities right. This estimation differs from person to person
thus fresh bouts of uncertainty. To many economists, the division of opinion
between deflationary and inflationary impact is more to do with the differences
in these subjective probabilities. Therefore, the policy impetus from the
government would also be subject to certain vagaries. There would be no right
or wrong formula. The crisis has created a scenario of shooting in the dark
alley given the information one possesses. While if there is going to be
inflationary tendencies it would be cost push rather than demand pull. The policy
makers must watch with caution on these directions as they plan the stimulus
package.
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