India as a political economy, has been on a roller-coaster ride over the last three years or so. A lot of hype (of reforms push) got created around the time the new government assumed office in India. Macroeconomy as well as stock markets obliged in the first two years or so by producing optimistic numbers.
Demonitization approached India like a real path-breaker for the political economy of India. The expected outcomes from demonitization (flowing out of the govt's discourses) kept on changing - from unearthing black money to curtailing terrorism to controlling corruption. Eventually, it could be worked out that the most evident intent was to convert the informal economy into a formal economy. Whether this was successful still remains a question but nevertheless, it threw Indian economy a challenge of sorts that has not been addressed in a desired way.
The next big thing - GST - was waiting in the wings and didn't have to wait too long before arriving. With slabs touching as high as 28% and procedural bottlenecks rolling the roost, GST (in its current shape) gave another blow to the economy (particularly the informal economy). General prices in the country have risen sharply since the introduction of GST (in July 2017). Applying GST on oil commodities could have helped ease the pressure from general price level but could have hit the exchequer's revenues badly; causing the government to keep oil commodities out of the purview of GST.
Demonitization and GST, which witnessed to be the epicentres of political mudslinging so far, are now getting reflected in the overall economic picture of the country. Heavy selling by FIIs in September (On 28th September, FII selling touched a whopping 5000 crore Rupees), falling rupee, low GDP growth, rising inflation, etc, have become a cause of concern. These problems are macroeconomic and fiscal, nevertheless.
As a matter of solving these bigger problems, the government seems to be building pressure on Reserve Bank of India to offer monetary solutions including softening the interest rates further. As an alternative, various measures could be considered - GST slabs can be revisited, cesses may be done away with, infrastructural expenditure can be increased, etc.
In my opinion, trying to increase the money supply in the economy cannot help solve the problems that are fiscal in nature. I am sure you have got some interesting inputs in this regard. Let's deliberate on it further.
I agree with you. The best what can central bank do with monetary policy is to keep appropriate level of inflation. Making economy work is the task for government. In particular, it should solve problems that are preventing economy from working well.
Central banks have different roles in different countries. I am not sure to what extent is the Central Bank in India called to deal with macro-stabilization. A significant fiscal system change, does not matter the purpose or quality of it, will generate a shock. Such a shock can be to some extent mitigated by Central Bank use of monetary polices. In my opinion as the fiscal measures are the cause of the shock, ONLY monetary policy can counter-balance the shock. If the solution is increasing liquidity by reducing mandatory reserves, or decreasing the interest rates, or something else is debatable. Any new fiscal system has issues that can be expected to slow down capital liquidity and money flows for a while. In this case in order to prevent a destructive financial blockage, increasing money supply can be mandatory.
Dear Prof. Sharma,
You have brought into discussion a very topical issue and the developments in Indian Economic policymaking over the last twenty five years or so which is quite interesting. I feel inclined to make some comments. If you care to take a look at my www.econometricsociety.org/[email protected] website you will see that I have computed the DGE for the Indian Macroeconomy (
open which means open stock markets) for about this period with published research, some of which has been published in Nature.com, so it has to be fundamental results in Natural Human Behaviour in Markets that has been analysed and calibrated. What we have found for work done for the Planning Commission of India (doesn't exist any longer ) and on related analysis, in consonance with a latest trend in DGE approach to Macroeconomic Research, which focusses on prices in particular stock prices , and growth per capita, which I humbly claim I have added to the literature, but is yet to pick up, especially from the Emerging Markets Cluster of the UN view point, is that the Indian Markets post this globalisation and liberalisation (twin policies adopted in the 80s and 90s) is in DGE even when you consider Meta-Heuristics like Asset Depreciation in Macroeconomic data explicitly. Admitting that most Indians like me would have loved to see the Rupee stabilise at around Rs.50-55 to the US Dollar, the Dynamic push to GNP, which obviously has been market microstructure driven (Mallick (1993, 2007, 2012)), has smoothly operated the multiplier-accelerator mechanism, thereby in a short time doing away with market imperfections. Now as I have derived in Mallick (2011) Social Welfare can be structurally and informationally controlled in a sustainable way by suitable monetary policy initiatives, given that our Commercial Banking system has been adequately greased as discussed before. But 'Bounded Rationality" not only of the "speculative demand" type has to be eliminated by education and laws. We should educate people not only to earn money but to raise their capacity of scientific decision making in various fields based on hands on laboratory based work.Sorry for the length. Hope to attract readers.
Soumitra K. Mallick
That's why I mentioned Commercial Banking not Development Banking and the Planning Commission. But your emphasis on the poverty issue is very much acknowledged.
Soumitra K Mallick
A small point on one particular observation of yours.
Transition from agrarian pre-capitalist to industrial capitalist economy, from informal to formal economy has always the master trope of development paradigm of a fantasy -social dream - that we are asked to believe in, participate and defend. The logic of what demonetization is supposed to do (if I take your point as correct which I think was indeed was one of the central objectives that was camouflaged by the rhetoric of black money) was already there, in fact has always been there. If I may recall, in the 2012 economy survey, prepared by, paradoxically, Raghuram Rajan, the importance of this transitional logic was reasserted with vigour. It sought labor intensive manufacturing led growth as the driving force to gobble up the population migrating (voluntarily and involuntarily) from the villages and towns (which it took as inevitable; hence the hollowing out of population from rural and small town as inevitable). In that spirit, this present government started with 'Make in India' but ended with the unexpected demonetisation as the mechanism to realize this fantasy.
Thank you very much my learned fellows... It is good to see you taking the discussion further, and more so, in the spirit of discussion. In continuation of your responses (and as a summary of the discussions so far), I wish to submit the following -
- Yes, running the economy is government's role, which has to be met through the combination of fiscal and monetary measures. Central bank's role is just to chip in with the accurate monetary measures whenever required. Both the arms of economic policy need to function in conjunction (rather than conflict) with each other.
- That fiscal shocks can be mitigated through monetary measures is an interesting and thought-provoking idea. Monetizing the debt, however, will certainly lead to the inflationary pressures, which can be countered through increased production of goods and services (that also involves and depends upon improved infrastructure, which by itself is a result of structural and fiscal changes in the economy). This is where the very notion of 'mitigating fiscal shocks through monetary measures' need to be revisited in the sense that in order to avoid the side effects of such monetary measures, fiscal management will need to continue being spot-on (non-existence of this was the inherent point highlighted in the very question).
- While I find myself in agreement with the statement that 'there are gross leakages in money spending by government through schemes', but I somehow beg to differ with 'why to spend more'. My submission is that the loopholes need to be plugged rather than stopping short of spending.
- It would be great to hear more about 'Monetarism and fiscalism are hitherto myths for India'. It is certainly an interesting thought and I am sure it would be further interesting to be enlightened about it.
- That 'social welfare can be structurally and informationally controlled in a sustainable way by suitable monetary policy initiatives' is such a tempting idea. However, I am sure there are more arguments that need to be put on the table to justify or confront the idea.
- 'Scientific' v/s 'Behavioral/ Humane' patterns in decision-making are so very much 'in' for researches in our times. Good that we could even bring this in perspective here.
- What the government planned to deliver through initiatives like, say, 'Make-in-India', and what it could deliver through hurried implementation of demonitization and GST (which to me, is a great tool implemented with little finishing touch; therefore, a nearly wasted opportunity (so far)) created a huge divide between the policy measures and their expected outcomes.
Finally, I must say that I am extremely humbled by the responses from all the learned researchers. Your ideas have lent so many dimensions to the discussion. In my comments above, I don't mean to offend anyone and wish to continue the discussion in the spirit of discussion. You taking it further is the best thing that can happen here.
Regards,
Gagan
Wonderful Discussion! I am fairly convinced with the logic of supply creating its own demand. The increased production surely meets the problem of increased demand, which in turn helps keep inflation under check. However, the basic economic principle of equilibrium is contextual here. I believe that the biggest challenge lies in studying the gestation period between the challenge and its response. In some cases, monetary policy appears to be ahead of the fiscal policy and vice versa. The invisible hand (as outlined by Smith) is bound to bring the economy back to equilibrium, it is only a matter of time. Monetary and Fiscal policy measures act as a support tool to the working of invisible hand. These measures performing their respective roles in coexistence with each other as also with ecosystem cause the multiplier effect, which in turn, helps the invisible hand in reducing the gestation period and bringing the economy to equilibrium in lesser time.
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