Why retail segment needs a closer look for a response to stagflation ?

News reports have suggested that the Indian economy is heading towards stagflation. A condition where economy’s growth rate is low accompanied by rising prices.  

Conventional wisdom ascribes the notion that as the demand falls prices tend to fall. However, what is currently occurring may not be symptomatic of this effect. One needs to keep in mind that the demand and supply position is determined based on equilibrium conditions in the market.  

Stagflation though violates conventional wisdom in that sense. A shrinking economy is accompanied by high prices. More often than not the treatment is given in the demand side through rate cuts. The idea to put more money in the pockets to stimulate demand. This has questionable results. Many economies resorted to this measure in the recent past. Some going as far to suggest to literally ‘air drop’ money for people to take and buy stuff.  

This points to a deeper malaise in the demand side. People are not spending not because liquidity is an issue. People simply postpone their decision to spend. For instance, auto sales are down. Would providing cheaper loans help? It is being done right now, but the results are far from encouraging.  

What then could be a solution to this issue? Perhaps game theory has an answer however counter intuitive this is. 

In the simplest game, let us consider two players in the economy.  

Player A: Retailer 

Player B: Customer 

Two actions are  : 

Buy  

Not Buy 

The payoff matrix is as defined below.

If the customer is buying, then it indicates there is a demand. So the retailer would be incentivised to move towards rising prices. A demand curve logic sure works fine here. 

If the customer would have bought the good at the status quo prices, she would have gained a value for the product. However, is she buys it after rising prices, then the value of loss of money is greater the value of the product itself. 

In the event that customer chooses to not buy the product at prevailing prices, while the customer would not be able to fill the need for the product for the retailer, a no buy would indicate a cost for the retailer in maintaining the good. Having decided to not buy, the customer’s payoff is the same in the both events (I.e status quo on prices and on rise in prices). However, for the retailer, it makes sense to rise prices to cover the fixed cost and avoid going bankrupt. 

What could be the response or this? 

Clearly, the customer’s decision needs to be changed from ‘not buy’ to ‘buy’. The decision as noted above may not be related to need for loans. If that were the case, then there should have been results already. Loans have been made available cheap for few quarters now. 

Instead, of further cutting the rates, the government would do well to reduce the inventory costs. Utility rates for shops could be amortized to be paid over installments. Loans taken by firms could be dealt with in the same manner and infact announce a subvention in interest rates for those firms.   

In the long term, retailers need to be provided with a financial product that takes care of the risk when the customers decide to postpone their buy decision. Perhaps through an insurance that allows the risk for fixed costs. This way the retailers are protected from the arbitrary decisions of the customers.