Dear money, quantum's the worry

If money becomes more expensive, will inflation come down? In a predominantly industrial economy, yes, but in an economy where industry accounts for less than a quarter of GDP, not quite. Yet, the Reserve Bank of India (RBI) is persisting with a monetary orthodoxy that has been shown to have severe limitations. According to this orthodoxy, if money becomes more costly, demand for it will fall, pushing down the overall level of demand in the economy. This will then force producers and distributors to reduce prices. Eventually, even if absolute prices don't come down, the rate at which they are increasing will, and everyone lives happily ever after. Nice, but not good enough if you are not willing to also do something about the total quantum of money in the system. To see why, imagine a man who has had six glasses of whiskey in 90 minutes, making it one glass in every 15 minutes. To reduce his intake, the barman raises the price of each drink. If the drinker can still respond, he will reduce the rate at which he is drinking. But what about the alcohol already in his body?

India's problem is not dissimilar to the drinker's. Unless something is done to reduce the amount of money available for consumption, as it were, increasing its price will only have an impact — as the RBI knows well enough — after such a long time that we will never know what actually worked. In short, the time has come to tackle what, in jargon, are called ‘monetary aggregates' by actually impounding the money available with the banks. But given the structure of the economy and the economy-wide deficiencies, even this may not have much effect. The problem lies in the system's inability to improve productivity and efficiency through technology and competition. In other words, reform. Unless due attention is paid to these two aspects, the RBI will achieve the same result as the barman — a comatose customer.

This newspaper has been arguing for several quarters now that monetary policy shot its bolt quite some time ago. So, unless across-the-board reform is speeded up, the supply situation will not allow inflation to come down to the reasonable level of 4-5 per cent. Primarily, these reforms must aim, in the short run when no great investments can be undertaken, to reduce the transactions costs. These are huge in India, amounting cumulatively for each stage of the process, to around 15 per cent. Even a 25 per cent reduction in these costs will yield good results. Many of these reforms will have an adverse revenue implication but these will be made up by the higher production. Most of what needs to be done is known and can be achieved at the administrative level. What is lacking is not the political will, as is often alleged, but merely imagination.

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