Curbing Inflation Versus Promoting Growth - A Macro Economic Dilemma
My notes in an attempt to make sense out what is happening between what RBI thinks and what Industry thinks...
I remember my Macro Economics Prof telling
us that for an economist it is always difficult to make a choice between
"Curbing Inflation" and "Promoting Growth". This can be
seen in full colors in what is happening these days in the economic landscape
of India.
In an ideal world, improving the
output is always better and leads to inclusive growth, however in practical world
this process is slow. We cannot improve the output of economy overnight.
However, we should also not kill the means of increasing the output as well.
RBI/Govt is under huge criticism that
their vision is only one sided. Their means of curbing inflation is by monetary
policy of controlling interest rates. The idea is that if there is less money
in market, the demand will fall and hence the inflation will fall. This would
be a good move if the inflation is only demand pull; however the inflation
which we see today is a complex combination of demand pull and cost pull.
There are more chances that increasing the
rates would lead to industrial growth slowing down (which is already beginning
to happen). This in turn would hit the economy from two angles.
- The economy slows down, growth slows down, supply slows down.
- Demand slows down.
This is a recursive phenomenon which ultimately leads
the economy into recession, which will be based on what will fall more.
The experts always say that if inflation exists, but output/economy is growing at good pace, then it is
actually good for economy in long run. This is always a difficult, painful and a little
extended path to start off with, but would lead to an inclusive growth.
However still, inflation has always been a
sensitive issue for the government. The reason for this is more to do with
Social/Political environment. None of the parties are willing to sacrifice the
short term gains, which is the vote bank. None of the political parties are
going ahead and educating the masses that we need to live with inflation for
some time before good economic measures bear some fruits.
I do not have the knowledge and the
numbers which the government economists and statisticians have.
The need of the hour is to look at those numbers and decide how much
inflation can we withstand and then devise policies to grow the economy in
parallel instead of taking a short cut route. The government and
political parties need to give support to the economists to come out
with policies which are right for the economy.
I for one, never understood (as a layman, I might say), the policy of RBI increasing rates, to curb "inflation". When you say inflation, there are actually various indices, right? (Like the Wholesale Price Index, Food prices, and so on). Actually, with the RBI raising rates, isn't it bad for the overall economy, in that sense? Sure, it leads to "less money in the system", but that's only for the guys who're in it as speculative traders. How does raising rates actually help bring down (or is "supposed" to bring down) prices of foodgrains, or fuel, or daily essentials? Any idea?
ReplyDeleteHi Amit,
ReplyDeleteLet me try to simplify it.
The principal behind monetary policy (or what RBI is doing) is:
When you increase the rates the supply of money in the market is choked. Since there is less money in the market the consumption of goods will go down. When consumption/demand goes down the prices will come down and hence inflation will come down. So this principal just don't apply to speculative trading alone.
The above principal will aptly apply if the inflation is demand pull (which means that the inflation is due to less goods in market but more demand for it)
Any country's economy is extremely complex in nature where various other factors also come into place. As you mentioned that they track the economy using different indices and each have a different behavior. For example the demand/supply of electronic good will behave differently to that of food items with respect to higher rates.
Food grains are an entirely different ballgame. If "money supply" in economy decreases, you might defer buying a TV, but you are not going to overnight decrease your consumption of food. However there is a strata of people who will decrease there wastage on food. But again food related inflation is extremely difficult to curb using rate hike. The solution is to increase the production.
Hope it clarifies somethings.