The inflation spectrometer

News: Inflation is a macroeconomic phenomenon which is under pressure at global and local level.

Major driving factors behind inflation

Inflation is caused by a number of factors which may includ supply, demand, local and global factors.


The inflation started with the US fiscal stimulus during Covid-19. This pushed inflation. This led to increased demand when global production was impaired due to Covid-19.  This resulted into shortages and longer delivery times.

The wage-price spiral (when higher prices lead to higher wages, which in turn drive the next round of price hikes) is now visible in the US. This may be visible across the world.

The Russia-Ukraine conflict has made it harder to adjust with demand and supply disruption caused earlier. The conflict and the associated sanctions have reduced the global supply of food and energy.

The countries are competing for the remaining supplies of energy. This has been the driving force in pushing up prices.

In addition, Higher prices have also not triggered investments in new supplies yet, as suppliers lack crtainty on how long the shortages may persist.

Local drivers of inflation:

Inflation occurs when a stimulus pushes aggregate demand above the economy’s capacity to meet it. In India, the total government deficit is higher than in pre-Covid times. The recent fiscal steps to prevent a rise in fertiliser and fuel prices may lead to spreading of inflation over a longer period.

The rise in India’s current account deficit (CAD) suggests domestic demand, at present, is unsustainable.

The labour market is also the most important driver of sticky inflation. The NREGA work demand has reduced. It is the most reliable indicator of unemployment in India.

Some other drivers of Indian inflation are the rise in telecom tariffs, and the low base of cereals prices

Measures Taken

Nearly every major economy has announced energy subsidies due to domestic political compulsions as well as the need to sustain growth,

What are the issues in fiscal and monetary policy measures?

The fiscal and monetary measures have limited implications. They cannot offset the shortages. The above-mentioned fiscal measures will only prolong the period of higher energy prices.

Way Forward

The US federal fiscal deficit as a share of gross domestic product or GDP has declined. There is an ongoing switch between goods-to-services in consumption; shipping bottlenecks have been easing; global industrial production has restarted, and there is evidence of excessive inventory in many supply chains.

The US needs to do further monetary tightening.

The Monetary Policy Committee should target the inflation. Further, the consumer price index may provide a better measure of persistent inflationary impulses in the economy that monetary policy can try to address.

There should be normalisation of rates given the healthy post-Covid recovery.

Instead of using interest rates, the government can let the rupee weaken to address the BOP imbalance.

Source: The post is based on an article “The inflation spectrometer” published in the Business Standard on 7th June 2022.

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