inflation – the case of the baby and the bathwater

Economic analysis is not exactly my cup of Tea – but then as they say anyone can be an armchair economist.

I digress.

We are facing high inflation levels currently-that’s pretty obvious, prices of various products have increased drastically ( petrol / food). And, the government is fighting inflation by raising interest rates. the old logic is that when you raise the value of something ( money in this case) you have less of it going around – hence it should follow that the spending power of people comes down –  hence the prices of goods come down- you have less people buying( hence inflation comes down) .

The catch here is that the government(even private firms) raises the salary of its employees and the wages ( dearness allowance) pegging it to the inflation rate. If the rate rises the salaries of staff increases. So if you have more salary( to counter inflation)  you have more money to spend so prices of goods (smaller value items esp)  will not be going down as planned. but yes the higher interest rates will prevent one from investing in his business(in adding capacity etc) , the capital products will not find offtake. Hence the Growth rate of production is stalls or goes down.

Somewhat like the case of throwing the baby ( Growth) along with the dirty bathwater(inflation) .

Check this article by S Balasubramanian of Businessline for a clearer understanding of the issues.

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