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Merits of the status quo

April 07, 2008

 Abstract: In 2008, the Indian economy found itself in an unusual situation, with inflation accelerating and the growth rate declining. This put the RBI in a dilemma, because addressing inflation meant risking further slowdown in growth and vice versa.

Two general principles to guide the appropriate policy response by RBI have been laid out. By the first principle, the RBI’s response should be dictated by an assessment of the relative risks of addressing one objective versus the other, while the second principle requires the response to be sensitive to the probability of success. Since neither tightening nor easing of liquidity satisfies both the principles, the status quo emerges as a default option. The point to note is that the dominant contributors to the inflationary surge in 2008 were food items and minerals which are driven by global demand-supply mismatches. Such inflationary pressures are transitory and beyond the scope of domestic monetary policy.

Keywords: monetary policy; overheating; central bank; GDP growth rate; inflation; risk; liquidity; food

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