Friday, May 24, 2024
HomeOpinionsBeyond monetary policy: Crafting resilient economies amid supply-driven inflation

Beyond monetary policy: Crafting resilient economies amid supply-driven inflation

Also Read

Over the past few months, in light of subsiding inflation, both the Reserve Bank of India (RBI) and the Federal Reserve (Fed) made the strategic decision to hit pause on/reduce the frequency of rate hikes. The increase, which started over a year ago and was one of the steepest hikes in history, appears to have accomplished its primary goal of controlling inflation, but not without considerable time and immense challenges.

The year has seen a cascade of bank failures in the US, ironically precipitated by these very rate hikes designed to keep the economy in check. While Monetary Policy (MP) has proven to be a valuable tool in combating inflation, over-reliance on it can unleash unintended and disastrous consequences.

In many scenarios, inflation has been largely propelled by demand-side factors, where MP plays a near-perfect role. Take for instance the period of skyrocketing inflation that the US grappled with in the 1970s, and Brazil in the late 1980s. These were clear instances of demand-driven inflation, where MP — a tool to control the value of money in the economy — can effectively regulate the demand for goods and services.

However, in an era where inflation is predominantly driven by supply-side factors — as has been the case since the late 2000s — MP can’t be the sole tool we depend on. MP is by nature a reactive approach, and while this fits well with controlling the pernicious effects of demand-driven inflation, its effectiveness diminishes in the face of supply-side inflation, which is mostly precipitated by exogenous shocks like the COVID-19 crisis, the Ukraine war, or the Suez Canal blockage.

Another evident limitation with MP was seen in the 2008 crisis. The housing bubble, propelled by soaring home prices due to low mortgage rates, became a significant driver of core inflation in the US. While MP can temper demand for houses to some extent, the negative implications are that it could potentially dampen economic activity across sectors that have no direct correlation to the problem at hand, thus triggering a recessionary environment.

This doesn’t discredit the necessity of MP but underscores the need to question its sole efficacy during periods of supply-driven inflation.

Countering supply-driven inflation demands a combination of proactive, forward-looking policies and MP. Consider Egypt’s situation, which was significantly impacted by reduced wheat imports from Ukraine and Russia. A discerning trade policy ensuring a diversified wheat supply chain would have improved resilience against inflationary pressures.

While hindsight always provides 20/20 vision, as the saying goes, “The best time to plant a tree was 20 years ago, the second-best time is now.” This underscores the need for policies addressing supply-driven inflation that consider the unique constraints and possibilities of a given country.

India, for instance, possesses ample raw materials for domestic sourcing. However, due to inadequate logistics infrastructure, imports from international markets often become a more cost-effective option. The government is making strides in the right direction with road network expansions and the launch of the National Logistics Policy, which holds the potential to curb domestic logistics costs.

Given that India is one of the largest importers of petroleum (approximately 21% of India’s total import bill), enhancing public transport capacity through improved domestic connectivity could pave the way for policies incentivising the use of public transportation (for instance the German Public Transport Allowance), thus reducing overall fuel consumption.

While these examples may seem like targeted policy interventions, they represent the exact arsenal of tools needed. Tackling enduring supply-driven inflation requires precisely such dedicated, sector-specific, and forward-looking policy tools.

Even though MP can alleviate the immediate impacts of supply disruptions by easing demand, the true key to an economy resilient to supply-side shocks lies in the development of efficient logistical infrastructure, judicious use of resources, and diversification of value chains.

  Support Us  

OpIndia is not rich like the mainstream media. Even a small contribution by you will help us keep running. Consider making a voluntary payment.

Trending now

- Advertisement -

Latest News

Recently Popular