Here’s a paradox. Those who are adversely the most affected by inflation--politicians, consumers and businessmen--talk the least about it while those who are least affected by it—economists--talk the most about it.
Few of them, however, know anything about product markets. Their attention is on the money market and on public finances. This is ok but useful only up to a point.
Politicians, producers and consumers are bystanders because they cannot influence the rate at which prices go up. They are like passengers in a bus who can’t determine its speed.
Nor indeed can economists — who are also inside the bus — talk about it in anything except the most general terms like supply, demand, fiscal policy and monetary policy.
Truth is, no one really knows why prices rise, quickly or slowly. Inflation is one of the most abiding mysteries of the social sciences because what happens to inflation depends in a very large measure on what happens in local and micro markets.
But aggregating these into a single number for setting a meaningful inflation target is like pushing on a string--you think you are doing something useful but actually aren’t. This is because there is no logical reason for choosing one number over another. This is one of the unacknowledged secrets of economic policy.
Meanwhile people also tend to think of micro markets purely in terms of supply and demand, which is fine for agricultural produce and naturally occurring commodities. In fact, even in those that’s not the only explanation for inflation.
This is because people don’t take into account the effect of better quality on prices. Thus, if what you buy today is better than what you were buying in the past, the cost of that improvement in quality has to get reflected in prices.
In other words, a large part of the improvement in productivity has to get reflected in higher prices. Often the opposite mistake is made, that higher productivity will lead to lower prices.
And necessarily these higher prices happen in jumps because quality improvement happens that way only and not in smooth ramp-like ascent.
Can anyone control the height and timing of the jumps? The answer has to be no because these jumps can’t be predicted.
So controlling the money supply or the fiscal deficit are of limited value. Both focus on demand management, while the problem is almost wholly on the supply side.
And therefore, the Modi government, if it wants to come back to power in 2024 with a comfortable majority, must hugely increase its focus on the supply side. After all, the fiscal side is constrained by revenue, and the monetary side is constrained by the bond market. Both are self-correcting.
Among other things, in practical terms, this requires the PMO’s attention to shift from the finance and infrastructure ministries to other ministries that have a direct bearing on actual supply--both inputs and finished products.
It’s those ministries that tend to be the weakest links because the best talent, both political and administrative, is not deployed there.
Unless this problem is addressed more fully, the government’s go-to instruments for lowering the rate at which prices rise will depend on broad-spectrum solutions like financial and infrastructural improvements.
Lower interest rates and lower logistical costs are necessary but not sufficient. They are like a cricket wicket on which the players perform. But the performance itself depends on the players, or in this case, the ministries that can help improve productivity and supply.
Economics, to be meaningful, has to be about micro markets but unfortunately has lost its way. It must go back to microeconomics. So must governments.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
