US inflation and impact on India

Context:

Retail inflation in the US has risen to 6.2% which is the highest year-on-year jump in 3 decades. However, U.S. consumers withstood rising inflation to power a burst of shopping ahead of the holiday season.

Relevance:

GS-III: Indian Economy

Dimensions of the Article:

1. What is Inflation?
2. Rising Inflation in U.S.
3. Effect of US Inflation on India

What is Inflation?

• Inflation refers to the consistent rise in the prices of most goods and services of daily or common use, such as food, clothing, housing, recreation, transport, consumer staples, etc. Inflation measures the average price change in a basket of commodities and services over time.
• A moderate level of inflation is required in the economy to ensure that production is promoted. Excess Inflation is indicative of the decrease in the purchasing power of a unit of a country’s currency. This could ultimately lead to a deceleration in economic growth.
• In India, inflation is primarily measured by two main indices — WPI (Wholesale Price Index) and CPI (Consumer Price Index) which measure wholesale and retail-level price changes, respectively.

Rising Inflation in U.S.

• The Federal Reserve, the US central bank, targets an inflation rate of just 2%. Seen in that context, 6.2% inflation rate is a very sharp increase in prices.
• Typically, inflation spikes can be assigned to either an increase in demand or a decrease in supply. Currently, in the US, both factors are at play.
• The pace of economic recovery has been much faster than the supply chain recovery, and this has worsened the mismatch between demand and supply, thus triggering a sustained price rise.
• With the rapid rollout of the Covid-19 vaccination drive, the US economy posted a sharp recovery. A part of the inflationary spike came from this unexpectedly fast recovery in all-round demand from consumers.
• This recovery was further fuelled by billions of dollars pumped by the government to not only provide relief to consumers and those who lost their jobs, but also to stimulate demand.
• While the US has seen the sharpest increase in prices, inflation has surprised policymakers across most of the major economies, be it Germany, China or Japan.

Effect of US Inflation on India

• Indians import will become costlier.
• High inflation in the advanced economies, especially the US, will likely force their central banks to abandon their loose monetary policy.
• A tight money policy in advanced economies would imply higher interest rates.
• That will affect the Indian economy in two broad ways:
  1. Indian firms trying to raise money outside India will find it costlier to do so.
  2. The RBI will have to align its monetary policy at home by raising interest rates domestically. That, in turn, may further raise inflation because the production costs would go up.

-Source: Indian Express