From UPSC perspective, the following things are important :
Prelims level : Stagflation
Mains level : Paper 3- Challenges in projection of economic macrovariables
The Fed has raised its benchmark interest rate again by a whopping 0.75%. The Reserve Bank of India has also been forced to raise interest rates further but also take other steps.
Two challenges for policymakers
- Decisions in the Monetary Policy Committee (MPC) meeting are based on what the members of the MPC see as the likely course of the economy in the months ahead.
- But, the trajectory of the world economy, and its likely impact on the Indian economy, is imponderable.
- So, Indian policymakers would face two crucial problems.
- 1] Uncertainty due to war and Covid-19: First, the main uncertainty is due to Russia’s war on Ukraine and the resultant economic sanctions on Russia, as well as the zero-COVID-19 policy in China that repeatedly implements lockdowns leading to global supply bottlenecks.
- 2] Uncertainty in data: Policy has to base itself on data.
- If it is deficient, it introduces additional uncertainty, making projections for the future difficult and causing policies to fail.
- This will compound the problem that results from the global uncertainty.
Role of uncertainties related to Covid and Ukraine war
- Since early 2020, the SARS-COV-2 virus has caused global uncertainty.
- In a globalised interdependent world, production was hit resulting in price rise (inflation) and loss of real incomes.
- This has resulted in decline in demand and, in a vicious cycle, a further slowing down of the economy.
- As prices have risen globally and economies slowed down, many countries have faced stagflation.
- Decline in uncertainty: The uncertainty due to the novel coronavirus has declined in spite of waves of attack persisting because the impact of new virus mutants of the virus is milder and there is also immunity due to vaccination.
- However, China is an exception with its zero-COVID policy.
- It has been implementing strict lockdowns in the last six months, even when only a few cases of the disease have been detected.
The uncertainties due to Ukraine conflict
- The war in Ukraine and western sanctions on Russia have caused huge uncertainty since February 2022 (when Russia invaded Ukraine) and displaced the disease-related uncertainty, i.e., COVID-19.
- The reason is that the war is a proxy war between two powerful capitalist blocs.
- There is needless continuing suffering of the people of Ukraine, with a bombardment of cities, and this could escalate.
- The war and the sanctions have already affected the world economy and the Europeans in particular.
- The U.S. economy has entered technical recession with two quarters of GDP decline.
- As supplies of critical items supplied by Russia and Ukraine have been hit, prices have soared.
- Europe, the United States and India have experienced or are experiencing high inflation.
- The biggest disruption is in energy supplies from Russia, impacting production.
- The availability of food, fertilizers, metals, etc., have been hit as Ukraine and Russia are important sources.
- To weaken Russia, sanctions may be imposed on countries that carry out trade with it.
- Many Indian entities may face the heat since India has increased its imports from Russia, which undermines sanctions.
- China may also face sanctions since it has increased trade with Russia and is backing it.
Data related uncertainties
- Indian policymakers also face data-related issues.
- It is not only available with a big lag on most macroeconomic variables but for many variables, data are either not available or has huge errors.
- Errors in data: Policymakers rely on high frequency data to proxy for actual data.
- For example, very little data are available for quarterly GDP data which is used to calculate the growth rate of the economy.
- First, except for agriculture, unorganised sector data is not available.
- Second, for the organised sector, very limited data are available.
- Third, projections from the previous year or proxies are used — both these introduce errors when there are repeated shocks to the economy, such as the pandemic and now the war.
- Issues with price data: Price data too are problematic.
- The services sector is under-represented.
- Prices of many services have risen and expenditures on them have increased dramatically, thus changing their weight in the consumption basket.
- Common CPI: Further, the consumer price index is common for the upper classes and the poor.
- Earlier, there was a different index for various categories of people, which reflected the differential impact of inflation on people.
- This gave a truer picture of the economy and peoples’ distress.
Indian policymakers face the unenviable task of predicting the course of the economy for the next few months and even the year (or years) ahead because of the shocks and faulty and inadequate data. The problem is compounded by international factors.