Over the past few days, the US retail inflation has climbed to 6.2%, marking the highest year-on-year surge in three decades. This considerable increase in prices has garnered global attention, with India being one of the countries heavily invested in this development.
Understanding the Concept of Inflation
Inflation refers to the rate at which prices rise over a certain period of time. In India, the inflation rate is typically calculated year-on-year. That means if the inflation rate for a particular month is noted as 10%, it suggests that the prices in that month were 10% higher compared to the prices in the same month a year ago. India measures inflation primarily through two principal indices – WPI (Wholesale Price Index) and CPI (Consumer Price Index), which track changes in wholesale and retail-level prices respectively. The country follows a flexible inflation targeting policy that aims for 4 (+/-2)%.
The Impact of High Inflation on Individuals
A significant inflation rate can erode the purchasing power of individuals. This impact is felt more by the poor, who possess less money to cope with rapidly surging prices. Yet, a moderate inflation level is needed to stimulate production in the economy.
Exploring the Reasons for the Escalating Inflation in the US
The US Federal Reserve targets an inflation rate of just 2%. Given this benchmark, the recent inflation rate of 6.2% signifies a serious rise in prices. The two primary causes attributed to such inflation spikes include an increase in demand or a decrease in supply. Interestingly, both factors seem to be at play in the US. The country’s economic recovery is outpacing the supply chain recovery, resulting in a sustained price rise due to a mismatch between demand and supply.
Demand-Side Inflation in the US
The rapid roll-out of Covid-19 vaccines has led to a sharp recovery in the US economy. This has driven up demand from consumers, resulting in part of the inflationary spike. This demand was further fuelled by the billions poured into the economy by the government to provide relief to consumers and jobless individuals and stimulate demand.
Supply-Side Inflation in the US: A Result of Global Pandemic
The global pandemic in 2020 caused widespread lockdowns and disruptions worldwide, not just in the US. This led to companies laying off employees and severely curtailing production. The global production supply chain is yet to resume at pre-pandemic levels.
Global Inflation Trends: Impact on Major Economies
While the US has endured the highest increase in prices, inflation has caught policymakers off guard across most major economies, including Germany, China, and Japan.
Inflation in India: Pre-Pandemic and Current Scenario
Unlike most economies, India had already been grappling with high inflation before the pandemic. The situation worsened due to supply constraints during the pandemic, even though demand has not yet fully recovered to pre-Covid levels. Despite technically entering an economic recession, the Reserve Bank of India (RBI) hasn’t lowered its benchmark interest rates (repo rate) since May 2020. RBI plans to maintain its accommodative stance as long as necessary to revive and sustain growth and alleviate Covid’s impact while keeping inflation within target.
Core Inflation in India: An Emerging Concern
While the average inflation rate seems currently manageable, the core inflation rate, excluding food and fuel prices, is worrying. It is high and threatens to exceed the RBI’s comfort zone. The global increase in prices may further exacerbate India’s inflation.
US Inflation and Its Potential Impact on India
Global price increases will lead to higher imported inflation, making all imports more expensive for India and its citizens. High inflation in advanced economies like the US might force their central banks to tighten their monetary policies, leading to higher interest rates. This could affect the Indian economy in two main ways. Firstly, Indian firms seeking to raise money abroad will find it more expensive. Secondly, the RBI may be forced to align its domestic monetary policy by raising interest rates, which might further escalate inflation due to increased production costs.
Last Modified: February 13, 2024