Money & Banking

Policy rate hike hinders aggregate demand: Study

Our Bureau Mumbai | Updated on December 26, 2012

The peak impact of an interest rate hike is felt in the second quarter and takes about eight quarters to dissipate completely, the study says.

An interest rate hike has a significant negative impact on the growth of aggregate demand, a working paper authored 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.

It may be noted that the RBI hiked policy rates 13 consecutive times 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 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 slows down investment.

“While both will reduce aggregate demand, the one emanating from slowdown in investment could have longer term growth implications in contrast to the one originating from decline in consumption demand,” the paper explains.

The paper also states that the impact of monetary policy action on private consumption growth and exports growth is relatively subdued but there is a significant impact on investment demand growth and imports growth. It states that there is a negligible impact of monetary policy on Government consumption growth.

The paper assumes significance in the light of RBI keeping the key policy rates rock steady since the April monetary policy review. Governor D. Subbarao has so far staved off stiff pressure from the industry and Finance Ministry to cut key rates. However, in its mid-quarter review on December 17, RBI indicated that there might be some easing in the fourth-quarter of the current fiscal.

satyanarayan.iyer@thehindu.co.in

Published on December 26, 2012

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