Fiscal policy to support the poor and monetary policy to restrain demand
What then is the answer? Governments the world over should allow growth momentum to slow. It is simply unsustainable in many ways. Central banks should be given untrammelled freedom to manage short-run demand while governments work on augmenting long-term supply in sustainable ways.
Further, given that short-term demand management would squeeze the poor and that inflation would take time to come down, governments should use targeted fiscal policy to support the poor and the very poor with direct income transfers instead of tampering with the price discovery processes. The rest simply have to come to terms with it.
Instead, price-caps subsidise income categories that do not need government support. These further reduce incentives for producers to increase production to meet demand, which is what rising prices are all about. India is guilty of such follies. Price signals are essential for producers to boost supply and to restrain demand. Further, the middle and the upper income classes that benefited during boom times should be willing to or be persuaded to share the costs that boom conditions have entailed.
This underscores too the importance of running prudent fiscal policies during boom times. Quite simply, one saves for the rainy day in good times and to not overspend the fortune. Good times do not need fiscal boosters in any case. Among the countries that have been guilty of such a conduct in recent years is India and it might yet pay a price for it in coming years.
But, don’t bet on it happening
The reaction to the modest increase in the still-administered prices of energy products in India recently is a clear example of leadership failure at all levels and across the political spectrum. Short-term political gains and misguided public angst dominate national interest. When the Congress Party returns to Opposition benches, they will return the compliment. It hurts and will hurt India. Badly. It appears that the Indian democracy subsidises mediocre and inferior leadership more than the Indian government subsidises commodities.