GS Paper 3
Syllabus: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment
Source: IE
Context: Over the course of the next four days, the Monetary Policy Committee (MPC) of RBI will deliberate whether interest rates should be hiked further or not.
Background: Since May last year, RBI has been raising the repo rate (the rate at which the RBI lends to the banking system) → banks/other financial institutions charge higher interest rates → existing EMIs for home/car/business loans have been going up.
The pros and cons of raising interest rates:
| Pros | Cons |
| Contain inflation: Higher EMI would dissuade enough people from borrowing money to fund future economic activity → slowdown in demand for money → bring down inflation → “too much money chasing too few goods”.
|
● Hike per se cannot improve the supply of those goods and services
● Prevent the “second-order effects” of high inflation → refer to a spike in people’s expectation of future inflation ● Limit India’s economic expansion and make unemployment worse ● A contractionary/tighter monetary policy (higher interest rates) increases inequality in an economy |
Does bringing interest rates down reduce inequalities?
- From the 2008 Global Financial Crisis until the war between Russia and Ukraine, most central banks practised an expansionary/loose monetary policy → low-interest rates → flooding the economy with additional money → spurring economic activity.
- But, there was growing criticism that low-interest rates were leading to higher wealth inequalities.
- Here’s how: When interest rates are low → savers barely get any rewards (save-you-lose) → most of the wealth creation happens in the stock markets → stocks are mostly owned by the rich (invest-you-win).
What should be done given the harmful effects of both (contractionary/expansionary) monetary policies on inequality?
- Widening inequalities is a very long-term trend, which depends on deep structural changes in any economy such as globalisation, technological progress, demographic trends etc.
- A properly managed monetary policy promotes greater economic stability and prosperity for the economy as a whole, by
- Mitigating the effects of recessions on the labour market and
- Keeping inflation low and stable.
- There is the need to rely on fiscal policy (taxes and government spending programs) and policies aimed at improving workers’ skills to address distributional concerns.
Insta Links:
Mains Links:
Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC 2019)
