US slaps Imran Khan on wrist

US slaps Imran Khan on wrist

US hints Imran Khan is doing wrong in trying to...
Abu Azmi takes on RSS

Abu Azmi takes on RSS

SP leader Abu Azmi asks Maha govt to file FIR against RSS chief Mohan Bhagwat...

Column: Managing the transition from tight liquidity

Sep 20 2013, 04:38 IST
Comments 0
SummaryRBI might gradually just lower the MSF rate, using supporting liquidity infusion

In the week of central bankers, the Federal Reserve has surprised by holding back a widely expected cut in the monthly bond purchase programme. RBI is also widely expected to largely hold the main components of the monetary policy instruments, at best tweaking some parameters of the tightened framework it had put in place over the past couple of months. This perception is based on the match between objectives and instruments, the economic tradeoffs involved in the use of alternative combinations of instruments and the transmission channels for the chosen instruments to achieve the desired objectives.

In this complicated economic environment reminiscent of the impossible trilemma—currency volatility with persisting inflation and attempts to increase capital inflows—matching objectives to the available policy instruments is likely to be the key choice for the policy decision. Three principal objectives are price, currency and financial stability, with the first being primus inter pares. Price stability is the central objective of any central banker, whether operating with an inflation targeting mandate or a more general one including fostering growth and employment. If inflation expectations become unhinged, the potential of degeneration into a wage price spiral is a central bank’s worst nightmare. In an environment where most markets operate with a great deal of flexibility, a nominal anchor for monetary policy is one of the key decisions. In simple English, inflation expectations must be controlled.

The tradeoffs in balancing the objectives are well known. The growth-inflation tradeoff is normally the centerpiece. The fulcrum of a meaningful discussion of the tradeoff is a fix of the deviation of actual activity from “potential” output. If output has dropped relative to continuing high growth potential, there is a strong case for monetary easing, since adequate capacity presumably exists to buffer the consequent increase in demand. Otherwise, any demand increase will quickly lead to an inflationary surge. India’s potential output level is unfortunately not very well understood, and is an impediment to calibrating policy change, and even direction. A key question here are the mechanisms which permit continuing high CPI retail inflation even when there are ample signs of demand destruction. An interest rate defence of the currency is likely to have collateral damage on growth and thereby the fisc and the banking sector, prompting the next decision on whether to persist with the tight liquidity policy or letting the Rupee find its market level, albeit in

Single Page Format
Ads by Google

More from Edit & Columns

Reader´s Comments
| Post a Comment
Please Wait while comments are loading...