India, a missed opportunity

From Free Exchange: “Lights, action, cut”:

LIKE most other central banks, the Reserve Bank of India (RBI) has a schedule for its monetary-policy meetings—firm dates on which its top brass gathers to consider changing interest rates. But much of the important action is now taking place between such meetings. On March 4th, the RBI cut its main interest rate by 0.25 percentage points, to 7.5%, the second such reduction in three months. Like the previous cut, in January, it was made outside the bank’s normal cycle of meetings. Is anxiety about the economy making the RBI trigger-happy or does something else explain this?

The previous interest-rate cut in January came days after figures showing consumer-price inflation had risen by less than expected in December, to 5%. That left the RBI comfortably on track to meet its self-imposed goal of bringing inflation below 6%. So it decided to act quickly. The second unscheduled cut two months later seemed as if it might have been a thumbs-up for the budget presented on February 28th by Arun Jaitley, India’s finance minister. The RBI’s governor, Raghuram Rajan, had said before that further interest-rate cuts would depend on the government’s fiscal rectitude [I´ll offset you]. But on this occasion action was spurred by the publication a day earlier of a three-page framework agreement with the government that set the RBI a formal inflation target.

Instead of an inflation target, India could have “innovated” and chosen an NGDP level target!

The chart shows that it´s not too far “off target”.


Actually, it wouldn´t have to bring NGDP down to the original trend level, because it´s quite likely India´s trend level has risen somewhat. In the next chart, you can glean that real trend growth shifted up after 2003, which would increase the “optimal” nominal spending level.


With the recent drive for reforms contemplated in the latest budget, it is likely India´s trend real growth could remain for a long time in the 7%-8% range. Therefore, NGDP growth of around 11% is consistent with inflation at or below 4%, which is the desired target:

The RBI said in a statement on March 4th that it needed to act outside the normal policy-review cycle for two reasons. First it ought to quickly offer guidance on how it would go about its new task now that the remit was public. It said that its aim was not to get inflation to 4% by the start of 2016-17 but rather to reach that target two years hence. In other words, it is pursuing a gentle glide-path to the 4% target so as to minimise the output costs getting inflation down.


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