The Hindu Business Line : Monetary policy keeps economy on even keel

Judging the purchasing power of a currency with reference to gold should be more scientific than vis-à-vis other leading currencies (N. Shanmuganathan, 'Is our monetary policy sound?', Business Line, January 11.). But since 1950, not only the price of gold, but the overall price level (of all commodities) has risen phenomenally. In the light of this, the author analysed the soundness of the monetary policy pursued by India.

What affects economic policies

In the modern world, particularly in this era of rapid globalisation, factors affecting and influencing economic policies are many. Ceteris Paribus is a condition which is useful only for theoretical analysis of some fundamental economic principles.

There is the simultaneous onslaught of varied factors such as a steady increase in population, and Defence and welfare expenditure. Added to those are natural calamities that cause considerable dislocation. All these cannot but enormously increase the demand-side of the goods required, even as the supply-side is not likely to be flexible and cope correspondingly.

This has been the story for the last five decades, the world over. What else can be the outcome except a steady rise in the price level?

It should not be overlooked that in this situation, the price of gold itself is subject to all the influences mentioned above.

It would also be useful to note that in the 1930s itself, the famous `Quantity Theory' of money ceased to be valid; an increase or decrease in the supply and circulation of money did not result in the anticipated rise or fall of prices. This, in turn, gave rise to Keynesian theories, the `New Deal' of Roosevelt in the US, and so on.

In the light of the above, the question to be addressed should be: Is the secular rise in prices or price levels an important criterion in judging the soundness of monetary policies, especially when the rise has been global.

In fact, it would be appropriate to examine this question in the light of many considerations other than the fluctuations in prices and the corresponding changes in the purchasing power of a currency. A few instances in support of this approach, keeping specifically the picture of the economy in mind:

In the early 1990s, there was a sudden flight of capital from Mexico, resulting in deep economic crisis. Nothing of that scale has happened in India.

In the late 1990s, South-East Asian economies went through disastrous crises. India was never caught in such a predicament even in the critical years of 1990 and 1991. We did tide over a threatening crisis before the economy was overwhelmed.

A little later, Argentina was rocked by political crises, essentially caused by economic factors. For months on, long queues of disillusioned depositors in front of commercial banks were a common sight. Such prospects have not haunted people in India.

During that period (the 1990s), even Russia did not escape serious monetary crisis, warranting intervention of the International Monetary Fund and the World Bank to put the economy back in order.

Again, the notorious inflation that raged in Austria and Germany after the First World War is known to the people of India only from the books on economic history.

The wise ways

The Indian economy has been smooth sailing for long, mostly due to the right monetary policies. Even now two issues bolster the wisdom of the monetary policy-making. First, the caution in diverting funds from the bulging foreign exchange preserves to infrastructure projects.

This, in spite of the Planning Commission and eminent economists favouring such a move. Second, the caution in switching to total capital account convertibility. It should be a matter of gratification that renowned investors such as George Soros appreciate this stand.

More than all this, the impressive inflow of foreign remittances and the steady increase in portfolio investments are a clear index of a wise monetary policy, boosting the status of the rupee by the day.

(The author is a Bangalore-based freelance writer.)

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