Subbarao reserves ammunition
The Hindu Business Line, January 28, 2009, page 8
Third Quarter Review of Monetary Policy 2008-09.
-------------------------------------------------------------------------------------------------
The RBI has taken the right decision not to make any changes in the key policy rates, since what has been done in the last three months is substantial and it takes time for the effects to be felt, says A. SESHAN.
-------------------------------------------------------------------------------------------------
The Reserve Bank of India (RBI) has preferred not to make any changes in the key policy rates. This is an appropriate stand since what has been done in the last three months is substantial and it takes time for the effects to be felt before further measures are initiated.
The growth of Gross Domestic Product (GDP) in 2008-09 is now brought down to 7 per cent with a downward bias. Considering that it was 7.8 per cent in the first half of 2008-09, it will have to be 6.28 per cent in the second half. This appears doubtful going by the recent statistics on industrial production and exports.
The RBI acknowledges that it too is in a bind when it says that monetary ammunition has been nearly exhausted in many countries.
The indicative growth projection in the total flow of credit to the commercial sector from all sources by the end of the year is raised from 20 per cent to 24 per cent. Going by the trend so far, it is a moot point whether much can be achieved in the remaining weeks.
INFLATION
The RBI’s prediction of inflation at less than 3 per cent by the end of the year is somewhat optimistic. A further reduction can be achieved if the government cuts the administered prices of petroleum products such as diesel. But how much would bringing down the prices of essentials, even after reckoning with their inter-industry effects, help?
The RBI is, of course, cognisant of the double-digit inflation revealed by various versions of the Consumer Price Index (CPI). Here the hope is that the reduction in input prices will bring down commodity prices and the decline in Wholesale Price Index (WPI) will have a lagged effect on the CPI.
In the first place, so far as agriculture is concerned, there is no reduction in the price of a major input, namely fertilisers. Second, whether WPI influences CPI or vice-versa or it is a mutual two-way relationship is yet to be conclusively determined despite the battery of causality tests employed by econometricians for the purpose.
It is surprising that experts of the RBI have fallen for the naive and meaningless reference to the ‘base effect’ of the previous year. Does one fight inflation with the help of such a concept?
It would mean that the high inflation observed a few months ago was a blessing in disguise as it would have a favourable ‘base effect’ next year!
This ‘effect’ is an arithmetical explanation, not an economic one. The total amount of additional liquidity released during the recent period is Rs 4,28,000 crore, including the money unwound (Rs 40,000 crore) through a reduction in the Statutory Liquidity Ratio. With a fall in growth rate and money supply target increasing from 16.5 per cent to 19 per cent, where will all the additional funds go except to raise nominal incomes through inflation?
BACKGROUND DOCUMENT
The document Macroeconomic and Monetary Developments — Third Quarter Review 2008-09 provides an authoritative background for an assessment of the latest policy stance of the Bank. There are two outstanding features that deserve to be mentioned.
Besides being transparent, objective and plain-speaking, it has reference to money multiplier in the context of the changes in cash reserve ratio. This is a good beginning. In future, its actual value can be compared with the theoretical one and variations thereof can be explained.
There is, however, a need to incorporate a reference to the other equally famous income multiplier, associated with Keynes. It is the multiple impact of the initial expenditure on the growth of the GDP.
In fact, the stimulus packages announced by the Government in the area of spending and tax cuts are posited on this multiplier in combating the decline in the growth rate of the economy. So it is imperative to know its value to have some idea about the expected result of the measures.
Valerie Ramey finds from historical US data that the multiplier for public spending is not large in that country: $1 in public spending raises GDP by only $1.4 (Identifying Government Spending Shocks: It’s all in the timing, University of California, San Diego, June 2008) Hence, the expected large-size impact on the US economy due to the massive stimulus packages of the Federal Government has been questioned. Second, there is a detailed description of liquidity in the economy beyond what was covered in the earlier documents.
Incidentally, the Government appointed a committee under the leadership of the Finance Secretary to examine the liquidity problem that prevailed a few months ago. The Report has not yet been published.
The current thinking is that there is little fiscal space left for further stimuli and it is the job of the monetary authorities to take over. This is contrary to conventional Keynesian thinking.
The central bank can flood the economy and reduce rates drastically. But if the environment and expectations are not favourable for businessmen to demand additional credit, the extra liquidity makes a round trip and ends in reverse repo operations with the RBI, as is happening now.
STATE FINANCES
Another point is the role of the States in tackling the present crisis for which not much attention has been given either by the authorities or observers.
A few days ago, the finances of State governments were reported to have made a remarkable improvement with a few exceptions, as brought out by an excellent analysis of the RBI staff (State Finances — A Study of Budgets of 2008-09). It indicated the scope for stimulus packages of State governments.
However, the background document of the RBI puts a damper on this welcome development. It says that the revenue surpluses of States envisaged in their budgets may not materialise due to subsequent developments.
(The author is a former officer-in-charge of the Department of Economic Analysis and Policy, RBI. blfeedback@thehindu.co.in)
The Hindu Business Line, January 28, 2009, page 8
Third Quarter Review of Monetary Policy 2008-09.
-------------------------------------------------------------------------------------------------
The RBI has taken the right decision not to make any changes in the key policy rates, since what has been done in the last three months is substantial and it takes time for the effects to be felt, says A. SESHAN.
-------------------------------------------------------------------------------------------------
The Reserve Bank of India (RBI) has preferred not to make any changes in the key policy rates. This is an appropriate stand since what has been done in the last three months is substantial and it takes time for the effects to be felt before further measures are initiated.
The growth of Gross Domestic Product (GDP) in 2008-09 is now brought down to 7 per cent with a downward bias. Considering that it was 7.8 per cent in the first half of 2008-09, it will have to be 6.28 per cent in the second half. This appears doubtful going by the recent statistics on industrial production and exports.
The RBI acknowledges that it too is in a bind when it says that monetary ammunition has been nearly exhausted in many countries.
The indicative growth projection in the total flow of credit to the commercial sector from all sources by the end of the year is raised from 20 per cent to 24 per cent. Going by the trend so far, it is a moot point whether much can be achieved in the remaining weeks.
INFLATION
The RBI’s prediction of inflation at less than 3 per cent by the end of the year is somewhat optimistic. A further reduction can be achieved if the government cuts the administered prices of petroleum products such as diesel. But how much would bringing down the prices of essentials, even after reckoning with their inter-industry effects, help?
The RBI is, of course, cognisant of the double-digit inflation revealed by various versions of the Consumer Price Index (CPI). Here the hope is that the reduction in input prices will bring down commodity prices and the decline in Wholesale Price Index (WPI) will have a lagged effect on the CPI.
In the first place, so far as agriculture is concerned, there is no reduction in the price of a major input, namely fertilisers. Second, whether WPI influences CPI or vice-versa or it is a mutual two-way relationship is yet to be conclusively determined despite the battery of causality tests employed by econometricians for the purpose.
It is surprising that experts of the RBI have fallen for the naive and meaningless reference to the ‘base effect’ of the previous year. Does one fight inflation with the help of such a concept?
It would mean that the high inflation observed a few months ago was a blessing in disguise as it would have a favourable ‘base effect’ next year!
This ‘effect’ is an arithmetical explanation, not an economic one. The total amount of additional liquidity released during the recent period is Rs 4,28,000 crore, including the money unwound (Rs 40,000 crore) through a reduction in the Statutory Liquidity Ratio. With a fall in growth rate and money supply target increasing from 16.5 per cent to 19 per cent, where will all the additional funds go except to raise nominal incomes through inflation?
BACKGROUND DOCUMENT
The document Macroeconomic and Monetary Developments — Third Quarter Review 2008-09 provides an authoritative background for an assessment of the latest policy stance of the Bank. There are two outstanding features that deserve to be mentioned.
Besides being transparent, objective and plain-speaking, it has reference to money multiplier in the context of the changes in cash reserve ratio. This is a good beginning. In future, its actual value can be compared with the theoretical one and variations thereof can be explained.
There is, however, a need to incorporate a reference to the other equally famous income multiplier, associated with Keynes. It is the multiple impact of the initial expenditure on the growth of the GDP.
In fact, the stimulus packages announced by the Government in the area of spending and tax cuts are posited on this multiplier in combating the decline in the growth rate of the economy. So it is imperative to know its value to have some idea about the expected result of the measures.
Valerie Ramey finds from historical US data that the multiplier for public spending is not large in that country: $1 in public spending raises GDP by only $1.4 (Identifying Government Spending Shocks: It’s all in the timing, University of California, San Diego, June 2008) Hence, the expected large-size impact on the US economy due to the massive stimulus packages of the Federal Government has been questioned. Second, there is a detailed description of liquidity in the economy beyond what was covered in the earlier documents.
Incidentally, the Government appointed a committee under the leadership of the Finance Secretary to examine the liquidity problem that prevailed a few months ago. The Report has not yet been published.
The current thinking is that there is little fiscal space left for further stimuli and it is the job of the monetary authorities to take over. This is contrary to conventional Keynesian thinking.
The central bank can flood the economy and reduce rates drastically. But if the environment and expectations are not favourable for businessmen to demand additional credit, the extra liquidity makes a round trip and ends in reverse repo operations with the RBI, as is happening now.
STATE FINANCES
Another point is the role of the States in tackling the present crisis for which not much attention has been given either by the authorities or observers.
A few days ago, the finances of State governments were reported to have made a remarkable improvement with a few exceptions, as brought out by an excellent analysis of the RBI staff (State Finances — A Study of Budgets of 2008-09). It indicated the scope for stimulus packages of State governments.
However, the background document of the RBI puts a damper on this welcome development. It says that the revenue surpluses of States envisaged in their budgets may not materialise due to subsequent developments.
(The author is a former officer-in-charge of the Department of Economic Analysis and Policy, RBI. blfeedback@thehindu.co.in)
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