[Editorial Analysis] Planning an exit out of the easy money regime

Mains Paper 3: Economy
Prelims level: Monetary Policy Committee
Mains level: Indian Economy and issues relating to planning, mobilization, of resources, growth, development

Context:

• The Reserve Bank of India (RBI) embarked on an extraordinary expansionary policy to manage the financial pressures unleashed by COVID-19.

• Its slashed policy interest rates aggressively, flooded the market with an unprecedented amount of liquidity and instituted a slew of measures for targeted assistance to especially distressed sectors.

About:

• Expansionary policy: It is intended to boost business investment and consumer spending by injecting money into the economy either through direct government deficit spending or increased lending to businesses and consumers. Ex: Quantitative Easing, or QE, is another form of expansionary monetary policy.

• All of the following options have the same purpose to expand the supply of currency or money supply for the country: To decreasing the discount rate, to purchasing government securities, to reducing the reserve ratio.

• Expansionary fiscal policy involves reducing taxes or increasing government spending, shifting the aggregate demand curve to the right, and increasing output.

How RBI Manage the financial pressures of COVID-19?

• One of the big lessons of the global financial crisis is that any missteps on the exit path by way of commission, omission, or importantly communication, can be costly in macroeconomic terms.

• In such a scenario, RBI must be planning for a non-disruptive exit out of the easy money regime. Reversing a crisis-driven expansionary policy has to be a deliberative process, with the timing and sequencing carefully planned.

Challenges that the RBI will confront on the way out?

• To manage the tension between restraining inflation and supporting the recovery.

• This is a policy dilemma even when the macroeconomic situation is benign, the pandemic has made the dilemma much sharper.

• Monetary Policy Committee (MPC) review shows Inflation remained above the RBI’s target band for the past several months, and according to the RBI’s own estimates, is expected to remain above the band for the next several months.

• The MPC expects inflation to soften on its own in the weeks ahead as supply chains, disrupted by the lockdown, normalise, and the bumper winter crop comes into the market.

Way forward:

• Without structural reforms the above issues cannot be addressed.

• Coordination between Fiscal Policy and Monetary Policy Separating debt management from monetary management in order to make the central bank more independent would be a good move.

• The answer lies in the fragile state of the Centre’s finances, and its control over interest, pension and subsidy expenses

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