From UPSC perspective, the following things are important :
Prelims level : Monteary Policy basics
Mains level : Limitations of monetary pollicy
The reaction of global markets to the US Federal Reserve’s monetary stance suggests investors are vesting too much faith in easy money to promote investment and growth.
Why the emphasis on monetary policy
- RBI does have more leeway to reduce its repo rate now that the Fed has lowered its own lending rate in the US by a quarter percentage point
- An RBI rate cut may stem the slide in stock prices, but this can be rationalized only by virtue of the signal it sends of RBI’s intent to aid a sluggish economy, not for a quick revival
Limitations of monetary policy
- There is evidence to suggest that the efficacy of monetary policy is diminishing.
- In the West, this is largely because the cost of capital is already very low by historical standards
- Much cheap credit goes into chasing higher-paying assets around the world instead of spurring business activity
- In India, monetary policy is even less potent in spurring investment. Various other factors beyond the cost of capital act as a drag.
- Of the three- quarters of a percentage point reduction in RBI’s repo rate this year, banks have passed on barely half
- With consumption on a downtrend, the will of companies to borrow and invest is weak
- What might restore market sentiment are renewed inflows from abroad into Indian shares and securities set off by the Fed’s move
- Infrastructure spending spree
- Implementing a set of major reforms that allow market forces to play an effective role in most of the arenas
- Easing land acquisition rules and turning the country’s labour market flexible could have a dramatic effect on India’s appeal as an investment destination
- Reversal of some income tax rules seen as extortionary by rich investors
- LTCG tax could be given a rethink
It is a good time for reforms. Let’s not over-rely on monetary policy.