Wisdom After Covid

Context: Pandemic has set the stage for a decade of churn. Post-Covid economy needs intellectual re-evaluation.

Challenges before Central Banks in post-covid recovery phase

• Ideological threats: Serious doubt on long-standing wisdom that economy functions best with an “invisible hand” and it should not be jeopardised through government “intervention”.
  • In many countries, including in the US, industrial policy is back on the table.
  • Issues in global economic order: which is characterised by more markets, greater financialisation, less government and freer trade culminating in wider inequality and higher debt burdens.
• Rising Inflation: Inflation remains the greatest challenge before central banks globally.
  • Precarious expectations: Structural supply side issues and elevated inflation expectations will likely fuel a global inflation cycle.
• Technical difficulties in interpreting inflation: In modern version of Phillips curve, inflation depends on economy output gap variables and inflation expectations.
  • In India, link between inflation change and output gap was never strong, and with emergence of Covid-19, the link is completely lost.
  • Thus, the concept of output gap is grossly inadequate to explain the inflation behaviour in India.
  • “Inflation expectations” is not stellar, to drive the sustained inflation in post pandemic phase.
• Monetary policy paradox: To counter inflation, Central Banks can hike interest rates, but there are underlying problems associated with it, because
  • Every stakeholder is addicted to low or no rates.
  • Inflation caused by supply disruption is not amenable to monetary treatment.
• Bias in fiscal transfer measures in developing countries:
  • In US, government debt held by Federal Reserve banks increased by $3 trillion from end of 2019 till the second quarter of 2021.
  • The privilege for America is excessive whereas the burden is exorbitant for developing countries if they seek to emulate such a fiscal transfer from the central bank to the government.
• Crisis in energy sector: Within a year, global energy market gone from massive glut to massive shortage.
• Investment gap: In last decade, due to very minimal investments in commodities exploration, supply chains are significantly unprepared to meet the demand.
  • Despite shortage in semiconductor market, there are no closed plants to reopen.