Occurrence of Stagflation

Two possible theoretical explanations can be given for the occurrence of stagflation almost all over the world. The first explanation follows directly from our discussion of Phillips curve which explain a trade off between inflation and unemployment. The second explanation of stagflation was originally given by Friedrich. A von Hayek in 1991. According to Hayek monetary expansion by the banking system by causing lowering of the market interest rate below the natural rate causes previously unprofitable investment projects appear profitable. According the entrepreneurs undertake these unprofitable projects believing the decline in the interest rate to be permanent. subsequently, however when the market rate of interest rise the investment projects wrongly taken up in hand again become unprofitable and are, therefore, abandoned rendering the workers unemployed. In the event of hyperinflation. It may result in the general break down of the market economy.

During the past decade and a half, the India economy has been in the grip of stagflation. Prices have recorded steady rise, especially during the eighties. During 1990-91 inflation rate was 13.6 per cent while the food price index recorded a steeper rise of 16.3 per cent and of 25.4 per cent during 1990-91 and 1991-92 respectively. As against the prevailing inflationary trend in the economy , the industrial sector has been sluggish ever since1990-91. Production of sensal individual industries has redo red sharp decline. Electrical machinery, electronics automobiles rubber and plastics, leather, textiles and engineering products have been all in the grip of severe recession . perhaps the 11,000-crore automobile industry has been the worst effected forcing the manufactures of cars, two wheelers and light commercial vehicles to curtail production and lay off workers. Due to the slowdown in the agriculture and industrial production, the growth rate of real gross domestic product fell from about 6 per cent 1989-90 to 5.5 per cent in 1990-91 and to 1.5 per cent in 1991-92 value addition in the agriculture sector fell in by 0.8 per cent while that in the industrial sector fell by 0.3 per cent during 1991-92.

Stagflation in India can be tackled by adopting a two pronged strategy one to curb inflation and the other to accelerate the GDP growth rate by removing the imbalance the supply of and demand for industrial goods and by increasing production in the agriculture sector. In order to curb inflation in the economy the annual rate of growth money supply should be brought drown from the present rate of 16 per cent to 10 per cent. This has to be done not by curtailing credit but by reducing the budget deficits of both the central and state government. In order to remove glut in the domestic market exports should be stepped up. This however is possible only if the prices of India exports are made competition in the world markets. It requires escalation in the productivity in the export oriented industrial units.