Thursday, February 04, 2016

Growth rate is the politicians' call

In my post a couple of days ago, I wondered whether the political class would settle for the 7% growth rate that the RBI governor posits is consistent with macroeconomic stability. As the Economic Survey points out, growth will be in the range of 7-7.5% not just this year (perhaps, closer to the lower bound) but also in 2016-17. The PM and the FM are committed to raising the growth rate to 8-9%- that is crucial to the BJP winning in 2019. I said that what this means for fiscal and monetary policy is a call the political class must take.

Sanjaya Baru, writing in ET today, echoes my line of thinking. He argues, in effect, that economic objectives are too important to be left to professional economists:
While politicians in power should listen to professional opinion and weigh the pros and cons of a policy recommendation, it is useful to remember that fiscal policy requires political judgement and its implementation entails political management. If economists had all the answers, we would not have so many poorly performing economies in countries with the best-trained economists.
Consider the fact that while the best performing post-World War 2 economies have been Germany, Japan, China and South Korea, no economist from any of these countries (bar one German in 1994) has ever been awarded the Nobel Prize.
Clearly, there is no reason to imagine that imported economists stand on surer ground when it comes to macroeconomic policy than homespun ones. And merely because an economist has been correct on one policy issue (this appears to be a reference to Rajan's famous warning of an impending financial crisis in 2005) does not mean that he would be so on all.
The problem for the PM and the FM is that there is little agreement amongst economists themselves on whether or not we should stray from the fiscal deficit targets laid out in earlier budgets and whether there is a case for monetary loosening or not. The Mid-Year Economic Review, which bears the stamp of the CEA, Arvind Subramanian, suggests that a departure from the target would be justified if the fiscal space so created is used for public investment. On monetary policy, it hints that there may be scope for flexibly interpreting inflation targets and the glide path. Niti Ayog Chairman has weighed in in favour of both fiscal and monetary easing on several occasions. NIFPF director Rathin Roy wrote in BS recently:
The RBI will also need to look afresh at its inflation targeting mechanism. The analytical work on which the current inflation targeting band is based provides no technical justification for the target other than some references to what exists in other countries and what previous committees have recommended. An inflation target of four per cent is secured through interest rate policies that result in average lending rates close to 12 per cent. It is little wonder that investment demand is flat. If the RBI does not have the capacity to lower interest rates consistent with four per cent CPI inflation, then government must re-examine the policy justification for a higher target rate within the two to six per cent band. This is, finally, a political decision and the collapse in nominal growth rates provides a sufficient analytical basis for urgent reconsideration.

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