Economic basics suggest RBI’s 6.5% policy rate is apt

livemint.com:

Monetarism a la Friedman says that inflation everywhere is always a monetary phenomenon. Increasing money supply by lowering interest rates can bring about only short-term gains in terms of increased GDP. But as time passes, it will be inflationary, as price expectations and wages adjust to increased money supply.

On the other side, Keynesian economics advocates an administrative role in GDP expansion when an economy is operating at less than full capacity, with a fiscal and monetary push as the ideal way to support economic activity. Therefore, we have two opposite views on intervention, called the ‘fresh water’ and ‘salt water’ schools since the 1970s. Each school would run down the other, arguing that the other was only a special case of its own ‘true economics.’ The debate is relevant today to India, with a decision to be taken on monetary policy soon.

With the inflation trajectory coming down of late, there is a view that the repo rate should be cut. The argument given is that if this is not done, economic growth will get affected. The counter-argument is that with India’s growth pegged at 7.6% in 2023-24, that linkage is weak.

There might even be the risk of the economy getting over-heated if interest rates are cut at this stage. It can also be inflationary, diluting the effort put in so far to achieve price stability. Rate-cut enthusiasts argue that what’s important is that the central bank’s repo rate at 6.5% is very high and out of sync.

Further, core inflation (minus volatile food and fuel) is below 4%, and this is the component that is influenced by monetary policy. How, then, is one to look at this debate? Data on various aspects of the economy could throw some light on this issue. In the last 13 years