One can’t have low inflation and lower interest rates, says RBI guv

MUMBAI: Barely two days after releasing his exit letter, RBI governor Raghuram Rajan on Monday sounded a word of caution on reckless cutting of interest rates to

MUMBAI: Barely two days after releasing his exit letter, RBI governor Raghuram Rajan on Monday sounded a word of caution on reckless cutting of interest rates to spur industry, a key point of differences in opinion he had with some of his political critics.

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Speaking at the Tata Institute for Fundamental Research on Monday, his first public event after the surprise letter on June 18, Rajan said: “There are many who believe we are totally misguided in our actions. What is happening today is truly revolutionary... We are abandoning the ways of the past that benefited the few at the expense of the many.”

Defending RBI’s record in fighting inflation the RBI governor said one can’t have it both ways, “low inflation and lower interest rates .”

“The received wisdom in monetary economics today is that a central bank serves the economy and the cause of growth best by keeping inflation low and stable around the target it is given by the government. This contrasts with the earlier prevailing view in economics that by pumping up demand through dramatic interest rate cuts, the central bank could generate sustained growth, albeit with some inflation. That view proved hopelessly optimistic about the powers of the central bank,” he added.

RBI and the government have agreed on an inflation target of 5% by March 2017.

Later at an interactive session, Rajan said there was lot of scope for increasing domestic macroeconomic stability and “we are in the process to build that. Hence we will not face any slowdown anytime soon.”

“There is a short run trade-off between inflation and growth,” Rajan said. “In layman’s terms, if the central bank cuts the interest rate by 100 basis points today, and banks pass it on, then demand will pick up and we could get stronger growth for a while. The stock market may shoot up for a few days. But you can fool all of the people only some of the time. If the economy is producing at potential, we would quickly see shortages and a sharp rise in inflation. People will also start expecting the central bank to disregard inflation, and embed high inflationary expectations into their decisions, including their demand for higher wages.

On Brexit, the RBI governor said it could be “quite damaging” if it happens, but India is prepared to face any consequences.