Tackling Inflation | Gist of Rajya Sabha TV / RSTV (now Sansad TV) - UPSC PDF Download

Introduction

• Based on the assessment of the current and evolving macroeconomic situation, RBI’s Monetary Policy Committee earlier this week decided to increase the policy repo rate under the liquidity adjustment facility by 40 basis points to 4.40 per cent with immediate effect. The MPC also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. 
• The US central bank has also announced its biggest interest rate increase in more than two decades as it toughens its fight rising prices. Bank of England has also raised interest rates to their highest level in 13 years in a bid to tackle soaring inflation. Meanwhile International Monetary Fund (IMF) has revised down its forecast of global output growth for 2022 by 0.8 percentage point to 3.6 per cent, in a span of less than three months. The World Trade Organization has also scaled down projection of world trade growth for 2022 by 1.7 percentage points to 3.0 percent.

Monetary Policy committee:

• It is a statutory and institutionalized framework under the Reserve Bank of India Act, 1934, for maintaining price stability, while keeping in mind the objective of growth.
• The 6-member Monetary Policy Committee (MPC) constituted by the Central Government as per the Section 45ZB of the amended RBI Act, 1934. The first meeting of the Monetary Policy Committee (MPC) was held on in Mumbai on October 3, 2016.
• The Governor of RBI is ex-officio Chairman of the committee. The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (4%).
• An RBI-appointed committee led by the then deputy governor Urjit Patel in 2014 recommended the establishment of the Monetary Policy Committee.

 Monetary Policy objectives:

• It is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
• In India, monetary policy of the Reserve Bank of India is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth.
• The RBI implements the monetary policy through open market operations, bank rate policy, reserve system, credit control policy, moral persuasion and through many other instruments.

Challenges before the RBI:

• When it comes to monetary policy, the RBI’s most important mandate is to maintain price stability.
• To this end, the RBI is required by law to maintain retail inflation which is based on Consumer Price Index (CPI) at the 4% level (with a band of variation of 2 percentage point).
• But, another key concern for the RBI is the overall economic growth in the economy.
• Since, more often than not, retail inflation and economic growth tend to rise and fall at the same time because higher growth implies higher demand for goods and as such a spike in prices the RBI’s work is simple.
• However, at the current juncture in the Indian economy, economic growth has decelerated sharply even as inflation has sped up.
• So the challenge before the RBI was to balance the concerns of boosting growth while making sure that inflation does not spiral out of control.

Monetary Policy Instruments and how they are managed?

• Monetary policy instruments are of two types namely qualitative instruments and quantitative instruments.
• The list of quantitative instruments includes Open Market Operations, Bank Rate, Repo Rate, Reverse Repo Rate, Cash Reserve Ratio, Statutory Liquidity Ratio, Marginal standing facility and Liquidity Adjustment Facility (LAF).
• Qualitative Instruments refer to direct action, change in the margin money and moral suasion.

Quantitative Easing:

• Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to increase the money supply and encourage lending and investment.
• When short-term interest rates are at or approaching zero, normal open market operations, which target interest rates, are no longer effective, so instead a central bank can target specified amounts of assets to purchase.
• Quantitative easing increases the money supply by purchasing assets with newly created bank reserves in order to provide banks with more liquidity.

Quantitative Easing for India:

• According to some economists, the only medicine that can work is quantitative easing, a remedy authority isn’t even discussing.
• QE, quantitative easing, may not cure the patient, but it may well succeed in bringing India’s economy out of a coma.
• This kind of QE does have a couple of advantages. One, it lowers the long-term government bond yield.
• That reduces loan costs for risky borrowers, since government bond yields act as a benchmark.
• Two, a more liquid banking system with more low-yielding cash than higher-yielding bonds will be impatient to lend at least in theory.
• Yet this type of QE relies on loans being made. If the demand side of the economy is struggling, the impact may be limited because of the one thing it doesn’t do: lift money supply in the broader economy.

Easy Money policy today could lead to high interest rates in the economy tomorrow:

• Easy money is when the RBI allows cash to build up within the banking system—as this lowers interest rates and makes it easier for banks and lenders to loan money.
• Easy money is a representation of how the RBI can stimulate the economy using monetary policy.
• The central bank looks to create easy money when it wants to lower unemployment and boost economic growth, but a major side effect of doing so is inflation.
• When money is easy (i.e., cheaper) to borrow, it can stimulate spending, investment, and economic growth.
• If easy money persists for too long, however, it can lead to high inflation.
• Too much easy money can cause the economy to overheat. It can incentivize over-investment in projects with poor outlooks. Discourages saving since interest rates on deposit accounts are low.

Rising Inflation over a period of time:

• Inflation encourages current consumption (buy goods and services now before prices rise) and discourages savings.
• People with savings suffer in times of inflation as the purchasing power of their savings decreases as price levels rise.
• The real rate of interest (nominal rate less the inflation rate) is reduced in times of inflation.
• Real interest rates may be negative if inflation rate is greater than the interest rate. If so the purchasing power of savings declines. This discourages savings.
• People who have borrowed money benefit as the real value of loans decreases as price levels rise (loans are easier to repay in the future as prices and income rise over time).

Conclusion

• The latest Consumer Price Index data show retail inflation accelerated by almost 100 basis points to a three-month high of 5.03% in February, with food and fuel costs continuing to remain volatile.
• Domestic economic activity is starting to recover with the ebbing of the second wave.
• Looking ahead, agricultural production and rural demand are expected to remain resilient.
• Urban demand is likely to mend with a lag as manufacturing and non-contact intensive services resume on a stronger pace, and the release of pent-up demand acquires a durable character with an accelerated pace of vaccination.
• Buoyant exports, the expected pick-up in government expenditure, including capital expenditure, and the recent economic package announced by the Government will provide further impetus to aggregate demand.
• Although investment demand is still anaemic, improving capacity utilisation and congenial monetary and financial conditions are preparing the ground for a long-awaited revival.