The disruptions caused by Covid-19 and the lockdowns may make the work of macro policy more complicated than usual, simply by worsening the short-run tradeoff between growth and inflation.
Let me explain.
1/6
A major factor behind the growth-inflation tradeoff is that in any economy close to full capacity, there is excess capacity in some sectors, while others face capacity constraints.
2/6
Increasing aggregate demand in such a situation lead to more growth in the excess-capacity sectors but also more inflation in the sectors facing constraints.
This is the tradeoff.
3/6
Now, the Covid-related supply shocks are acute and very sector specific.
For example, the services sectors have become more supply constrained due to social distancing requirements.
Conversely, the industrial sectors seem to be facing strong demand constraints.
4/6
This stark difference in sectoral conditions mean that, compared to pre-Covid periods, any increase in aggregate demand, while increasing growth, will run into more supply constrained sectors, leading to higher inflation.
Clearly, the tradeoff is worse now.
5/6
Thus, macro policy may have to accept higher rates of inflation, in order to achieve a specific growth rate.
Or accept a lower growth rate if the aim is to keep inflation at a certain level.
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1. Agree with Viral that the banking sector has always been misused in India for political economy reasons. But assuming that the legislation of rules will prevent this is not consistent with developing country experiences.
It is well established in the institutions literature that countries simply pretend to implement rules but work around them when they are politically difficult to implement. Lant Pritchett calls this *isomorphic mimicry*.
Just look at how our budget deficits are being managed.
There's concern among many economists that Import Substitution is again becoming popular among developing countries as well as developed countries like the US.
IMO however, this conflation of the US situation with those in developing countries, misleads the debate. 1/9
Thread: Does Covid-19 crisis need Modern Monetary Theory (MMT) approach?
It has now become clear that the Indian govt. will run a large fiscal deficit in 20-21.
For funding this, some amount of Deficit Monetization looks inevitable. 1/12
Interestingly, the possibility of Deficit Monetization has given rise to discussions around MMT.
This is an unconventional approach in economics that is much more comfortable with the printing of money for govt. expenditures, than mainstream economics. 2/12
There are however, some important differences between economic conditions/objectives driving MMT, and those characterizing the economic crisis resulting from the epidemic.
These lead to important difference in policies as well. Here are some of them in the next few tweets. 3/12