Global inflation in the mid-1970s was historic, which gave central banks a bigger role to control prices.

The post-pandemic world faced a similar situation, at least in most developed countries where inflation was at a four-decade high. Most systemic central banks committed the mistake of delaying policy normalisation as they erroneously presumed the current episode of inflation to be transitory, arising due to Covid-related disruptions, including supply chain disruptions caused by the Russia-Ukraine war.

There were mainly two reasons why most central banks had to hike policy rates rapidly and in large magnitude. First, policy rates were at rock bottom in many countries with unprecedented liquidity injection during the Covid-19 pandemic besides fiscal deficits at historic highs.

Second, delays in the normalisation of monetary policy following a poor diagnosis of underlying causes of high inflation.

Amidst fear of global slowdown and recession in many developed countries, stakeholders have started debating the likely terminal policy rates for different countries. There was no such debate when the rate-cutting cycle started in the post-Global Financial Crisis period.

Even after reaching the zero lower bound, the global debate was to pursue quantitative easing for a longer period, even through helicopter money and achieve a negative interest rate, at least in developed countries.

Economic agents have been addicted to excess liquidity and unusually low-interest rate regimes, well below the rule-based policy rates.

Hence there is an asymmetry in expectations. The real policy rates are still negative in many countries and trailing much below the rule-based nominal policy rate. Expecting monetary policy to do miracles in stimulating growth may hamper the central bank’s independence as they fail to deliver on price stability.

The fight against inflation is not over despite the gradual moderation of inflation in many countries.

Arguments have been put forward for changing the goalposts — raising the inflation mandate by one percentage point above the current level (around 2 per cent in developed countries and 4 per cent in developing countries) or reverting to the inflation target over a longer time horizon, say three years.

Follow policy rules

It is better to follow the policy rules rather than find fault with the framework unless it is outdated.

Fiscal policy must return to fiscal consolidation in a time-bound manner failing which the debt-GDP ratio, which is already high in the wake of the Covid-related budget deficits, would explode as a global debt crisis. Developing countries, which have borrowed large amounts from overseas markets due to unprecedented compression of yield, may face both debt servicing and exchange rate problems.

Without fiscal consolidation, recent monetary tightening may not achieve its objective. Coordination between monetary and fiscal policies is best achieved when both wings of public policies are rule-bound.

In India, the real policy rate is marginally negative. The fiscal consolidation is on track. The government’s large capital expenditures shield the domestic economy from the spillover effects of global headwinds on growth. Both exchange rates and equity prices are resilient amidst volatility.

Financial sector parameters are better now than a few years ago. Monetary and fiscal policy coordination is improving which ensures macroeconomic stability in the medium term.

The writer is RBI Chair Professor at Utkal University and a former Head of the Monetary Policy Department, RBI. The views are personal

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