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T.C.A. Srinivasa-Raghavan

New Delhi, Nov. 1 Can a business confidence issue be tackled by flooding the system with money? The Government and the Reserve Bank seem to think so. So in the last month or so, the two have decided to pump in upwards of something like Rs 3,00,000 crore into the banking system — not counting the money multiplier.

The diagnosis — deficient demand — is essentially Keynesian, but the instrument is not. The two hope that by putting in so much money, they can revive aggregate demand.

This will not happen because the Keynesian prescription was different in its choice of agency. It recommended using fiscal policy for reviving demand. That meant direct investment by the government into public works, such as road-building, not indirect investment via two layers of intermediation — banks and borrowing firms.

This would work better, said Keynes, because firms do not decide to invest on grounds of public interest.

They invest for profit. So if firms decide, for whatever reason, that investment is not profitable, they will not invest. It is like taking the horse to the water.

It is this element of discretion that the Government and the RBI are not factoring in — and thus building up the mother of all inflationary potentials. The current dip in inflation is largely a statistical (base) effect.

It is worth noting that faced with a similar deficiency in aggregate demand, Japan had dropped interest rates to zero in the mid-1990s, to no avail. The US is getting near to a zero rate of interest — it is already at 1 per cent — and it would be a brave man who would predict a quick recovery there.

Keynes had worked this out, too. He called this phenomenon the ‘liquidity trap’. What happens is that banks worry that they will suffer capital losses and prefer not to lend. Usually, it is the fear of default that acts an inhibitor, especially during a financial crisis. The problem gets aggravated when nominal interest rates fall too low, because when they do start to go up, bond prices will go down, and cause losses.

Milton Friedman, the ultimate monetarist, had suggested a way out. Avoid financial intermediaries and give the money directly to people and business.

Perhaps, because of its control over the public sector banks, this is what the Government hopes to do: Order to them to give away money. This was called helicopter money, because it is dropped by the central bank like confetti!

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