Today’s oil shock is unlikely to hit India like past ones did—but that’s no reason for complacency

The ongoing war in West Asia has cast a pall of uncertainty over the global economy. The disruptions in energy supplies have begun to ripple through supply chains across the world. In its latest monthly review of the Indian economy, the finance ministry has noted: “Recent shocks are being transmitted through higher input costs, supply constraints and pressures across sectors, with early indications of some moderation in economic activity.”For economic policymakers, managing a disruption in supply is far more complicated than responding to a sudden shift in demand.

The reason is simple. In the case of a demand shock, both output and prices move in the same direction. For example, a sudden drop in demand in an economy will lead to slower growth as well as lower inflation.

The textbook solution of stimulating the economy through lower interest rates as well as higher government spending usually works well. Supply shocks are very different. Output and prices move in different directions.

For example, a shortage of supplies means that economic activity slows down while inflation moves up. The textbook solutions lose their bite in these extraordinary situations, creating tricky choices between either supporting growth or taming price increases.A lot will depend on how long the war will last. The best strategy right now would be for the government to absorb some of the initial price increases through either tax cuts or higher subsidies, while the Reserve Bank of India waits along the sidelines.