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Tightmonetary policy Vs Economic growth

For an emerging and developing economy like India, it has always been a Hobsons choice for the central bank to select between the followings: A: Economic-growth that is propped up by liberal monetary policy OR B: To rein in inflation through tight monetary policy. Obviously, the ideal and sanguine scenario would be Moderate inflation coupled with high growth rate. However, esoteric market dynamics and panoply of macroeconomic variables make it a difficult if not an unattainable target. It is widely construed (and to some extent rightly so), that economic growth is inversely related to the monetary policy. Many exhaustive literatures explaining the reasons behind the aforesaid are available in the market. Some of the reasons (Rather major reasons) are elucidated hereunder: A: Economic growth increases the income of the people of the country and there is a demand side pressure on the prices, which ultimately leads to inflation. B: Liberal monetary policy in terms of low repo rate, reverse repo rate, CRR, SLR etc. makes the money relatively cheaper and abundant in circulation and this leads to reduction in purchasing power of the currency and hence inflation. Proponents of economic growth suggest that for a poor country like India, economic growth should take the precedence as there is no alternative of it. They stress upon the fact that even if the growth rate is impeded because of the increasing the cost of money (through plethora of monetary instruments viz. interest rate, CRR, SLR, repo rate, reverse repo rate etc., which are at the disposal of the countrys central bank), the inflation will not come down instantaneously. Reason being, inflation is not always a demand side pull. Instead, it is largely due to bottlenecks in supply chain and inefficient distribution mechanisms and delivery systems, that the country witnesses uncontrolled inflation. Indian subscribers of this view, put forward examples of 1970s and 1980s when the hyper inflation was due to supply constraints and not because of liberal monetary policy. We had a stringent monetary policy at that point of time; still we had witnessed one of the worst kinds of inflation.

Scholars who represent the case of moderate inflation, present a different perspectivealtogether. They emphasize on the fact that when inflation is high, the real rate of interest goes down and people have got less or no incentive to deposit their money in bank and this in turn restricts the funding of the infrastructure projects and other developmental activities because of the dearth of available money. Hence it is imperative for any country (especially developing country like India) to have a firm grip on inflation before attention is deviated towards growth consideration. In India, monetary policy is a tool available to RBI to respond to the market stimuli. Moreover, growth target is set by the planning commission, in consultation with the economic advisory council. RBI and planning commission both have to work in tandem to create a financially tenable and economically viable model of development for the country. Sustained journey in the trajectory of growth target is indispensable for India if it has to improve and bolster its stature as a formidable player in the global proscenium. But it is equally important for the country to have a controlled inflation as well because it is the price rise that affects the poor the most. With sustained inflation, many more people are thrown below poverty line because their real purchasing power comes down. Moreover, it is to be understood that the effect of economic growth takes time to percolate down to the masses and more often than not, the benefits of economic growth in a country like India is enjoyed by a chunk of major players in the markets and the benefits dont even reach to the poor. But, in so far as inflation is concerned, though the well-off section of the society may not feel the impact that much, the poor get the pinch instantaneously. So, it has always has been a difficult choice for RBI to tailor the monetary policy in a way to have an optimum rate of inflation and growth. Whenever the country faces the downturn, because of the turmoil in the external market, it decreases the rates so as to make rupee cheap, to ensure that country continues to witness sustained growth. When persisting and intractable inflation pesters the nation, the tightening of screw takes place.

The Inflation rate and various policy rates for past few years are given in the graph:

Quite predictably, at the time of global recession during 2008-09, RBI eased monetary policy rates to ensure adequate liquidity in the market. As soon as inflation started raising its head and jumped outside the comfort zone of RBI, rates were increased to control the flow of liquidity in the market. Recently in July, RBI increased the policy rates because of persistent and intractable inflation. However, for quite sometime, despite increasing the rate, inflation is not moderating and questions are being asked about the efficacy of the monetary policy of the central bank. In this regard, it must be understood that the monetary policy has got its own limitation and beyond a certain point it cant contain inflation. Inflation may have been catalyzed due to poor harvesting, infrastructural lacunae, dilapidated delivery mechanism and global inflationary pressure. Under those circumstances, the impact of tight monetary policy will be mediocre.

It is imperative to mention here that monetary policy related instruments are time tested tools in the hands of central banks but they are no substitute for prudent fiscal management, capacity building, technological capabilities, proper market development and access and efficacious supply chain. If India is to prosper, these issues have to be addressed from the scratch and synchronization has to be established between fiscal policy and monetary policy to reap the full benefits of sound macroeconomic management policy. This sound macroeconomic management policy coupled with immaculate supply chain management will be a giant leap forward towards the attainment of the developed nation status.

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