The poor are paying for inflation targeting

Profit-driven inflation should be curbed by increasing corporate taxes, introducing price ceilings on a range of goods and services of everyday use, using the additional tax revenues on subsidising wage goods, or things that the working people consume. And if the state ensures that the prices of most goods are kept in check, then there would be no reason for workers to demand higher wages; there would not be any inflation expectation to worry about.

Temporary: If prices continue to rise, India’s central bank might return to its path of raising interest rates. Reuters

Aunindyo Chakravarty

Senior economic analyst

THE Reserve Bank of India (RBI), India’s central bank, had been on a rate-hiking spree since last summer. That has been finally stopped. Contrary to what most economists expected, the RBI has not raised its key interest rate, the repo rate, in its latest monetary policy review. The repo rate is what commercial banks have to pay when they take short-term loans from the RBI. When it is low, banks too can charge less to their customers, whether they are business or consumers. Since May 2022, the RBI raised the repo rate five times, taking it from 4 per cent to 6.5 per cent, making loans significantly more expensive.

Why did the RBI raise rates so quickly and then bring it to a halt? It was, and is, following textbook economic theory. Low rates encourage people to invest in big-ticket purchases. They take home loans because EMIs (equated monthly instalments) look affordable. They take car loans and even buy gadgets on monthly instalments. This results in an overall rise in demand for goods in the economy. Businesses respond by increasing their production and borrow money to buy new machines and expand their shop floors and offices. If interest rates were high, they would think twice, because the high cost of financing their expansion would offset any gains to be made from increased sales. Low rates would reduce that risk and encourage investments.

As production is increased, businesses would have to hire more people. And as the demand for labour increases, employees would have more options, they would want bigger pay packages. This would result in two things — workers would spend more and cause a further rise in the ‘aggregate’ demand in the economy, and the rise in wages would push up production costs. The net result would be higher inflation, caused by a rise in demand for goods and services and also a rise in wage costs. As inflation goes up, workers will demand even more wages, in anticipation that prices will continue to rise in the future. This ‘inflation expectation’ will fuel further inflation.

Neoliberal ‘mainstream’ economists argue that inflation expectations cause a wage-price spiral which results in uncontrolled runaway inflation. The focus is always on the share of national income that goes to the working class. They ignore what happens to profits. Almost everywhere, high inflation is driven by periods of excessive profits. Since demand growth precedes any expansion of capacities, corporates always take advantage of short-term supply shortages by raising prices. They also raise prices in anticipation of having to pay more in the future for raw material and labour. In other words, corporate profiteering causes prices to rise, which is what raises the inflation expectations of the workers they employ.

Such profit-driven inflation ought to be curbed by increasing corporate taxes, introducing price ceilings on a range of goods and services of everyday use, using the additional tax revenues on subsidising wage goods, or things that the working people consume. And if the state ensures that the prices of most goods are kept in check, then there would be no reason for workers to demand higher wages; there would not be any inflation expectation to worry about.

But that would make corporates unhappy. So, mainstream economics, which effectively speaks for owners of capital, would never recommend such steps. In fact, a majority of economists do the exact opposite. Taxation and price control, according to them, curb entrepreneurial spirits, discourages investments, resulting in higher unemployment and lower standard of living. Their go-to weapon is monetary policy, controlled by ‘independent’ central banks. Mainstream economists say that the right way to cool prices down is to tighten the amount of money sloshing around in the economy by raising the interest rates. Once rates are raised, corporates will face higher finance costs; they will be more careful about their investments and look to improve productivity to reduce other costs. So, they will sack people and make those they keep work for longer hours and under more intense conditions. This drop in demand for labour will cause wages to fall, and that will reduce the overall demand, causing both wage-push and demand-push inflation to decline.

This is what all nations have been doing for the past three decades, since finance capital captured the global economy and the world fell in line with neoliberal economic policies. Inflation is always curbed by raising interest rates, in order to slow down consumption demand and curb wage increases. The burden of reducing prices falls on those who are least able to bear it. Unemployment goes up and wages fall, till the demand for both consumer goods and raw materials falls. That is when central banks step in again and stop raising interest rates. This is how economists maintain the fiction of the efficient ‘free’ markets, which are best left to run on their own. They conveniently forget that central banks are actually part of the government sector, integral to the state.

It is this neoliberal dogma which led the RBI to raise interest rates by 250 basis points in less than a year. This has achieved the effect it wanted to. Government data shows that household consumption has grown by just 2.1 per cent in the last quarter of 2022, compared to where it was in the same period in 2021. Now, there is a danger that household consumption expenditure might contract, instead of rising. Even in this situation, economists wanted one last interest rate hike, because retail inflation is still above the 6 per cent mark, which has been set as the upper limit for the RBI. Technically, the RBI is supposed to intervene whenever inflation crosses that level. Luckily, politics has trumped ‘neoliberal’ economics and the RBI has weighed in on the side of growth, instead of being rigid on inflation targeting.

For the working people of the country, who pay both for inflation and for inflation-curbing policies, this might just be a temporary reprieve. If prices continue to rise, India’s central bank might return to its path of raising interest rates. This is likely, especially because in this globalised world, the RBI has no option but to follow what more powerful central banks do to ensure higher rates in the West don’t cause a flight of capital.