The good side of inflation: Accelerating prices make govt debt management easier. Higher food prices mean bigger farmer income

Context: Some positive effects of inflation.

How is inflation beneficial in some respects?

A higher inflation (consumer price index or wholesale price index) helps in the lowering of the estimated fiscal deficit. The fiscal deficit, is calculated as a percentage of the nominal GDP. The nominal GDP because of the way it is calculated on current prices includes the inflation component. To estimate the real rate of GDP growth, statisticians net out inflation using a GDP deflator, a weighted average of CPI and WPI. A higher inflation would therefore shrink the deficit just as a higher subsidy reduces the nominal GDP.
This is how India managed to maintain an elevated level of fiscal deficit (including off-budget public spends like oil subsidies) for 5-6 years post the Global Financial Crisis, without blowing out on debt to-GDP ratios. It was made possible because of high single-digit, near double-digit inflation for most of that period.

Partial reversal of Terms of Trade in agriculture: A somewhat less straightforward, but perhaps more high-impact consequence of inflation is a partial reversal of the terms of trade (ToT) in agriculture. It’s well-known that ToT in farming has been on a decline in India.

The phrase ‘terms of trade’ for agriculture broadly refers to the gap between the price paid for inputs used in growing agricultural crops, and the prices received from the sale of those crops.

Even when the retail inflation went up, the farmgate prices lagged behind, but this trend has been reversed now A synchronised inflation in the last one year – substantial increase in MSP last year and a global uptick in food prices as a result of the war in Ukraine – means. Farmgate food price inflation is trending significantly above retail price inflation.

The price increases are not restricted to cereals like wheat. Milk, cotton, edible oils – the anecdotal evidence of higher farmgate prices is adding up. Perhaps it’s temporary, but ToT is shifting just a tad bit in favour of the farmer due to the current inflationary spell. In other words, it’s an income transfer from urban India to the farmers.

Way forward

In short, inflation is a policy paradox. Policymakers need to find a balance, rather than condemning inflation as an unmitigated evil that it is projected to be in popular discourse.

Source: This post is based on the article “The good side of inflation” published in The Times of India on 11th May 22.

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