Is anyone thinking this through?

 

Now that the CSO has put this year’s growth at 7.1%, higher than what analysts had pegged it at, and inflation is way lower than anyone expected just a few months back, the clamour for sharp rate cuts begins all over again. Now I wonder whether the slashing of rates as demanded by most economic advisors is just a part of the herd behaviour or is anyone thinking this through at all! When the RBI had cut rates on 2^nd Jan, why was there an expectation of further cuts at the end of the same month? TCA had this piece on the independence of the RBI where he says it has rightly resisted the call to cut rates.

 

As John Taylor says in the WSJ yesterday, highlighting the policy mistakes that have led to the crisis (and there are many!), 

A third policy response was the very sharp reduction in the target federal-funds rate to 2% in April 2008 from 5.25% in August 2007. This was sharper than monetary guidelines such as my own Taylor Rule would prescribe.

His final take?

Massive responses with little explanation will probably make things worse. That is the lesson from this crisis so far.

 

Unfortunately, even applying the Taylor’s rule has numerous problems in India, given the way inflation, output, employment or the lack of it are measured! Ajay Shah writes some of that in his blog. So we have major issues here of application of even existing theory, forget the need to have a relook at theory itself - is inflation targeting really the role of the central bank?Read George Cooper’s book Origins of Financial Crises for more on this, or Anantha Nageshwaran’s summary of its salient points.

 

So what’s the prescription? Well, for one, be humble, lets face it, people don’t know what’s happening. There is lots to do in understanding the theoretical underpinnings of financial instability, measure the economic variables properly etc..In fact, at the Finance Ministry meeting last month, I was quite surprised to see invesment bank economists, who had been and still are at the center of the storm, pronounce so confidently on what needs to be done ahead. Check out M. Govind Rao, Director NIPFP on how even models are using guestimates now.. and Niranjan Rajadhyaksha  in the Mint on what lies ahead.

Let’s stop pushing for rate cuts and fiscal stimuli in quick large doses, take measured steps, don’t expect miracles. Chances are high that if you do have wonders in the short-term, there is much more pain in the long term…after all, one of the reasons for the present crisis is the low interest rate regime in the US post 2001, thanks to Greenspan..the higher you fly, the sharper you land. Let’s try for a more sustainable recovery this time round.

Last 5 posts by Sumita Kale

• Walk the talk with Steve Keen - February 26th, 2010
• Elinor Ostrom and Economics - October 13th, 2009
• Garbage - September 10th, 2009
• Energy and risk - August 27th, 2009
• Any defence for the dismal science? - August 19th, 2009

Tags: inflation targeting, monetary policy, rate cuts, RBI

This entry was posted on Tuesday, February 10th, 2009 at 4:21 pm and is filed under Indian Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.