Monday, January 6, 2020

Increasing the efficacy of monetary policy

Another data point has been released with the rate climbing once again. And as expected, commentators are invoking the “stagflation” ghost. Meanwhile, the Reserve Bank of India (RBI) continues to chase completely dissonant goals, intervening to weaken the rupee even as they maintain a high level of real interest rates.
Monetary policy, especially when operating through the interest rate mechanism, cannot address emerging from consumption items in which demand is either price inelastic and/or interest rate inelastic. Consumption of these items is also called non-discretionary consumption because these items typically include only necessities. Any change in prices of these can cause brief deviations from their trend demand patterns, but not a change in the trend itself. As would be obvious, changes in interest rates do not have much of an impact on the consumption of these items. As such, it is unusual for to respond to changes in the price of these items because, well, it can’t do much about it. Higher interest rates do not have an impact on the demand for food and retail consumption of electricity.
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This note was published in the Business Standard on December 22, 2019. 

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