The Hindu Business Line : Different approaches

August 8, 2008 may not only be remembered for the spectacular opening ceremony of the Beijing Olympics. It will also be remembered for the Federal Reserve’s decision to hold rates that helped the dollar stage its biggest rally in recent times.

This was preceded by a steep 3.25 percentage point rate cuts since September last that had helped the dollar find its place among global currencies. Following the Fed’s latest move, the US currency climbed to levels not seen since the beginning of 2008. Responding to the dollar gains, spot crude prices fell and September futures closed lower by four dollars, as the world capital markets cheered. Gold prices fell to eight-week lows. Fears of US inflation loomed large as the Fed had reduced interest rates to their lowest levels. However, the measures followed by the US and India to stabilise their economies are radically different. The US followed a cheap money policy of consistently reducing interest rates to trigger economic momentum while, at the same time, keeping an eye on inflation. India, on the other hand, pursued a dear money policy of raising interest rates, primarily as an inflation-targeting measure, while consistently admitting that it could hurt economic growth impulses. Despite their different approaches, the preliminary indications suggest that both the economies might be just be turning the corner.

Inflationary spiral

Though the threat of a slowdown and recession still looms large over the US economy, the rally in the dollar could be a harbinger of happier days ahead. Also, the cheap money policies have not resulted in the much-feared food inflationary spiral. In the Indian context, the inflationary spiral still looms large. But the acceleration seems to have been checked and further growth in inflation could be marginal. A slowdown in economic growth has been predicted but is nowhere near alarming levels. The policies and responses of the US and India are different because the strengths and weaknesses of the two vary.

India is a fast accelerating economy with growth impulses at the 8-9 per cent levels, and the planners believed that these impulses could be sacrificed to a certain degree to ensure price and economic stability. The US, on the other hand, remains a stable and mature economy growing at around two per cent and the threats of inflationary spiral have been, by and large, overlooked.

Inflation and growth

The global inflationary spiral took its roots from a spike in international crude oil prices and a mismatch between food grain production and demand. But the US remained one of the least affected countries because it is a large surplus grain producer and among the major exporters in the world. The food inflation in the US was not perceived as a major threat since the per capita spending on food by an average US family was around 13 per cent of the total disposable income. It was also seen more as an outcome of soaring fuel prices and less as a threat to food security. The situation in India was vastly different with food consumption seen as the most significant component of an average individual’s per capita income. Bridling inflationary traits, which have soared to the 12 per cent levels, was perceived as a primary objective of the planners to ensure price and economic stability. And inflation-targeting took precedence over growth dynamics.

Though we are not out of the woods as yet, both the strategies seem to be yielding results.

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