India Economy

Ways to kickstart economic activity

Ramaprasad R | Updated on June 09, 2012

BL10MACRO-TUBE1

BL10MACRO-TUBE

With our country's GDP growth rate slowing down in the last two quarters, people believe that the RBI is likely to adopt a “quantitative easing” policy to get the economy back on track. What does “quantitative easing” mean?

It means that RBI is directly or indirectly making more money available in the economy to boost spending, which in turn boosts economic activity. How does this work?

When more money is available, people tend to spend more on goods and services, and, thus, the sellers see their incomes rising.

These sellers are also buyers — they buy goods and services other than the ones they sell. This in turn increases income to other sellers, and the chain continues. This income-multiplying process typically jump-starts economic activity.

Such measures that infuse more money into the system to get the economy rolling are referred to as “quantitative easing” policies. The RBI can also reduce the money supply when required.

The Modus Operandi

The RBI has different tools in its kitty to alter money circulation in the market. One of the popular methods that it uses is to change the interest rates.

People either save or spend money. When the interest rates are decreased, the incentive to save is that much lower. When savings decrease, spending naturally increases.

Also, when the interest rates are lowered, the cost of borrowing for private investments becomes lower and, thus, the quantum of investment increases. This is associated with increased hiring which, in turn, translates to higher employment and income; all of which leads to increased economic activity.



Other methods to alter money suuply

Besides interest rate changes, the RBI can influence the minimum cash balance that other banks are required to maintain. If this minimum reserve balance is reduced, banks would have more money to lend.

For shorter term cash management, the central bank also engages in what is called open market operations, where it sells or purchases bonds in return for money. When the RBI decides to infuse money into the market, it buys bonds in return for money, and vice-versa. Such policies that inundate the economy with money are collectively called “quantitative easing” policies.

Central banks other than the RBI also engage in quantitative easing to help ease credit, and boost economic activity. Recently, during the 2008 credit crisis, the US Federal Reserve bank implemented two successive quantitative easing policies to help the economy get back on track.

Published on June 09, 2012

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