The RBI responded to the pandemic created recession through monetary policy and associated interventions to supply low-cost money to the businesses and the consumers with a hope to build up the economy. Surprisingly the results were not as desired. This piece of article will examine, does the government has an alternative if the monetary policy is found to be not so effective?
Many central banks in the world use monetary policy as a financial tool during crises to strike a balance between furthering the domestic recovery and manoeuvring inflationary pressures. However, as an outcome, there has been a considerable delay in the transmission of policy effects and observance of the subdued outcome of economic growth has been found.
“The federal government with its currency system can print money as and when they need to spend because they cannot go insolvent unless a decision is taken”
The recession has posed many unusual challenges within the economy, those include massive unemployment due to sudden halt in economic activities, unrepairable SME business damages, a risk-averse behaviour of financial institutions etc. Many economists feel that this typical nature of the economic set of characteristics has developed an adverse environment for monetary policy to entrust impetus in the economy for growth. What is more, it has diverted excess liquidity to the stock market in risk assets in search of higher returns rather than channelling it for growth.
However, as a consequence of policy implementation, in India, the Reserve Bank of India could able to manage to restrict 10-year treasury bond yield in a passive band of 5.8-6.1 percent, but this could only help the government to raise law cost funds to take some fiscal initiatives, nonetheless, it could unable to grease the wheels of economy through a dovish stand of Monetary Policy, as a major intervention, for faster growth. These manifestations pose challenges before RBI, on accounts of, what to do next? Here the role of a fiscal policy starts.
The Indian government has adopted to take various fiscal measures during the pandemic to come out from the difficult situation of glaring unemployment and subdued growth. The Indian government responded to the crisis through the various fiscal packages of more than 25 trillion rupees; the measures included free food grain supply to the poor, DBT to the farmers and the SME workers, support to employers, support to industry through PLI schemes, etc.
Modern Monetary Policy(MMT) has become a much-discussed topic in recent days, as an alternative to monetary policy. The book, written by Stephanie Kelton “the deficit myth”, advocates the use of a policy tool for sovereign countries which spend, tax, and borrow in fiat currency that they control. This macroeconomic framework envisages that these countries are not constrained by revenue when it comes to federal government spending, especially in the sectors such as health, education, and infrastructure.
The contractionary nature of recessions induced by financial crisis makes it attractive towards this policy tool, especially when there is a disappointing performance of monetary easing including lower than expected recovery rate and inflationary performance. Moreover, the poor performance of dovish monetary policy on the front of inequalities and poverty, the governments look to fiscal measures to support livelihood and to boost consumer demand.
The central idea of Modern Monetary Policy is that the federal government with its currency system can print money as and when they need to spend because they cannot go insolvent unless a decision is taken. Wouldn’t such spending be financially irresponsible and debt-unsustainable, because a deficit could be extremely harmful and cause a slowdown in the economy since it would build people’s savings?
Stephanie Kelton dispels the fiscal myths in the following way: first, she says the federal government is not like a household or a private business that need to come up with a rupee before spending, but the government is not dependent on revenue always and can never go broke. Second, the government’ deficit is someone else surplus in the economy, thus overspending may not be harmful to the economy; though it is true that in such situations government would be living beyond its means.
“MMT recommends a new automatic stabiliser, known as a job guarantee programme. It advocates direct funding employment for those without work because it is a driverless stabiliser, the steering wheel will always turn in the right direction at the right moment in time.”
Third, will deficit burden the next generation? Kelton says the rhetoric is powerful but not of any economic logic. The reality is that government spending doesn’t force financial burden forward onto future populations because this could be the period during which the middle class is built and real median family income soared. Fourth, it is a myth that deficit is harmful because it crowds out private investment and undermines long-term growth. This myth is on the foundation that government competes with the private sector for limited savings. She says, indeed reverses is true, the fiscal deficit actually increases private savings and can easily crowed-in private investment.
Theory proponents believe that unemployment is the result of too little spending by the government. It is more close to the heart of developing economies like us where the private sector doesn’t have capacities to employ all eligible youth. It says those looking for work and unable to find it elsewhere in the economy should be given minimum-wage transition jobs funded by the government and managed by the state and local governments.
MMT recommends a new automatic stabiliser, known as a job guarantee programme. It advocates direct funding employment for those without work because it is a driverless stabiliser, the steering wheel will always turn in the right direction at the right moment in time. It is a kind of mechanism, where, when the economy improves and the private sector is ready to begin hiring again the fiscal deficit shrinks. This would make it an automatic powerful stabiliser of the economy and fiscal norms.
MMT theory which was once an obscure ‘heterodox’ thinking in economics has now become a topic of hot discussion. Some have called it a naïve and irresponsible policy prescription, where debt sustainability and the inflationary nature of outcome have been the main points of controversy. Nobel prize-winning economist Paul Krugman in his article in the New York Times in 2011 says “do the math and it becomes clear that any attempt to extract too much from seigniorage- more than a few percentages of GDP, probably – leads to an infinite spiral inflation,” also that “In effect, the currency is destroyed”
Where would India fit-in to adopt this policy? The US prints dollar, a global reserve currency, but India prints Rupee. We need a dollar to pay for imports in a way that depends upon foreign currency reserves, thus having financial constraints. Nevertheless, the Indian government mostly borrows in Rupees. The fifteenth financial commission in its report estimated that public debt will be at 85.7 % of GDP in FY 26, which will be when the government will take adequate measures to reduce it gradually from the current year onwards. MMT points out that monetary sovereignty has complete control over the domestic rate of interest and it can keep it low at least till the period inflation begins to rise.
The interaction of the Indian financial system with the global system is not simple rather a complex one, which makes India in a position of price taker than a price maker. In nutshell, Indian monetary policy is not sovereign. What is more worrisome for India is that the definition of full employment. Most of the labour market in India is unorganised and informal, which often provides seasonal employment. Many a time, productivity is low, and too many workers are employed to occupy a few job positions.
India has a complex set-up in terms of economic agents and sectoral characteristics. The monetary policy does have some role to play to create money for the organised sector, but a low policy rate for elongated duration may be harmful. Also, when excess liquidity in the market does not flow to the needy businesses and households may push the economy into an inflationary phase or an asset price bubble formation.
In such a situation, as long as government spending is to support the hard-hit downtrodden segment of the population and spending is meant to create developmental infrastructure the role of the fiscal policy cannot be denied. Despite many constraints, the MMT is a tool that can help nations during difficult crises – such as present one – with a proper mix with other financial policy interventions.
