An interest rate hike reduces growth of aggregate demand, a working paper by Jeevan Kumar Khundrakpam, Director in the Monetary Policy Department of the Reserve Bank of India, has revealed. It finds that the peak impact of an interest rate hike is felt in the second quarter and takes about eight quarters to dissipate completely.
The RBI had hiked policy rates 13 times consecutively since March 2010 before hitting the pause button. It cut the repo rate by 50 basis points in April this year.
“By now there seems to be a general consensus that monetary policy affects the real economy, at least in the short run. This has been confirmed by most of the empirical studies in the literature,” the paper adds.
The research has found that higher interest rates following monetary tightening can push households to postpone some of their planned consumption and save more. The same higher interest rates can also make investments more costly and, therefore, temporarily slow down investment. “While both reduce aggregate demand, the one emanating from a slowdown in investment could have longer-term growth implications, in contrast to the one that follows a decline in consumption demand,” the paper explains.
It also states that the impact of monetary policy action on private consumption growth and export growth is relatively subdued, but there is a significant impact on investment demand growth and import growth. It states that there is a negligible impact of monetary policy on government consumption growth. The paper assumes significance in the light of the RBI keeping key policy rates steady since April .