Archive for October 20th, 2011

How India’s fiscal policy continues to dominate monetary policy?

October 20, 2011

Another nice paper from RBI econs. This has always been the case but with FRBM you thought the dominance would reduce. Biut nothing like that ha happened:

This study analyses the behaviour of monetary and fiscal policies interaction in India using quarterly data for 2000Q2 to 2010Q1. It finds that, even after the elimination of automatic monetisation of fiscal deficit in 1997 and prohibiting RBI from buying government securities in the primary market under the FRBM Act from April 2006, fiscal policy continues to substantially influence the conduct of monetary policy.

Specifically, the reaction of the two policies to shocks in inflation and output is mostly in the opposite direction. While monetary policy reacts in a counter-cyclical manner, fiscal policy reaction is primarily pro-cyclical in nature. The positive impact of expansionary fiscal policy on output is highly short-lived, while there is a significant negative impact in the medium to long- term.

Read the paper for more details..

From negatively sloping Philips curve to Backward Bending Philips Curve

October 20, 2011

RBI has been explaining this idea of backward bending Philips curve in may speeches and papers. The concept has helped RBI explain (atleast tried to) that there is a threshold level of inflation where the curve bends backwards. Hence, instead of inflation acting as a grease for growth it acts as a sand.

This paper from RBI econs Sitikantha Pattanaik and G V Nadhanael explains the whole shift in thinking from (-ly) sloping Philips curve to backward bending Philips curve.

Table 1 in the paper is titled – From NAIRU (-ly sloping) to MURI (Minimum Unemployment Rate of Inflation or backward sloping Philips curve). In the table you have the equation of Philips curve and how it has changed over the years. It is just amazingly explained.

Table-1: Growth-Inflation Tradeoff in Theory– from NAIRU to MURI

1.   w = f(u – u*)                                                                      Lipsey (1960)
2.   π = f(u – u*) + πe                                        Friedman (1968) and Phelps (1968), Lucas (1972)
3.   π = f(u – u*) + λπe                                                             Tobin (1971)
4.   π = f(U – U*) + λ(U)πe                                                        Palley (1994, 1997)
5.   π = f(U – U*) + πe(π)                                                          Akerlof (2000)
6.   π = f(U – U*) + λ(πee                                                      Palley (2003)

Source: Palley (2011, 2008)

Read the paper for details. It is a must going back to basics of Macro..

The paper towards the end looks at threshold level for India and comes at the same conclusions as this paper – around 6%.

I just have one problem with these India growth-inflation papers. Indian growth story is very recent and is not even a decade old. So say you study the threshold from 1970s or 1960s, most of the data you get is of low growth and low inflation phase. Compared to other developing econs, India’s record on inflation has been more sober. So, you get much lower threshold level for inflation.

Since 2006 we have started to face both high growth and high inflation. I believe calculations will change as we move on in this current India growth story phase.  I mean just like threshold inflation we have threshold growth as well where inflation starts to rise moment it crosses the threshold. This threshold is widely believed as 8-9% but is actually much lower. The potential may be much higher but for that you need adequate supply as well.

Nevertheless, nice paper explaining concepts neatly. If not every bit you get some flavor..





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