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The interest rate pendulum

July 27, 2009

 Abstract: Despite central banks repeatedly cutting policy rates, market interest rates rose globally since early 2009, because the large increases in government borrowing to finance fiscal stimulus packages (announced in the aftermath of the Lehman Brothers bankruptcy) more than offset the impact of monetary actions on interest rates. To spur growth during this stage of the business cycle, the government had no choice but to step in. But, going forward, continued large government borrowing could reduce the scope for private investment and consumption spending, thus impeding a faster and more widespread recovery.

Cutting back fiscal deficit to create space for private spending would not be difficult for those countries that typically balance their national budget during normal times. However, in countries like India, where fiscal deficits are large even in normal times, significant new initiatives will be required.

Keywords: central banks; anti-inflationary stances; market interest rates; fiscal stimulus; recovery

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