As expected, the Reserve Bank of India (RBI) in its first quarter review of monetary policy on 31 July decided to leave policy rates unchanged, though it lowered the statutory liquidity ratio (SLR) to 23% from 24%. The central bank also revised its growth and inflation projections. The growth projection for the current year was cut to 6.5% from 7.3% in April. The inflation projection was, however, revised upwards, to 7% by the end of March 2013 from 6.5% as projected in April.

The making of monetary policy will get further complicated as RBI now expects inflation to remain higher than growth in the current year. Although RBI intends to control inflation and inflationary expectations, pressure will mount to cut rates to push private investments and growth.

RBI is not the only central bank to be stuck between a rock and a hard place. Elsewhere, the Federal Open Market Committee (FOMC) of the US Federal Reserve, which began its two-day meeting on Tuesday, is also under tremendous pressure to do something in order to arrest the pace of deceleration in the economy. The US economy is reported to have grown at 1.5% in the second quarter of calendar 2012 compared with the revised rate of 2% in the first quarter. The FOMC is also expected to take steps to bring down the unemployment rate, hovering at a politically unacceptable level of 8% as the US prepares for its next presidential election.

Meanwhile, in the euro zone, struggling with falling economic activity and rising bond yields in large economies such as Spain and Italy, European Central Bank (ECB) president Mario Draghi pledged last week to do “whatever it takes” to save the single currency, which lifted the mood in the debt market in Europe and stock markets all over the world. Both these large central banks (Federal Reserve and ECB) are under pressure to start asset purchases from the market, an activity also known as quantitative easing. The Federal Reserve has done this twice in recent years and along with other factors this has brought down yields on the US papers to a historical low.

Now the question is: will bond buying from the open market solve the underlying problem, and how will these central banks deal with the unintended consequences of monetary expansion? In the case of ECB, it will certainly help bring down the yields in the struggling economies and give them much needed breathing space. However, it is not clear if it will be able to win the confidence of the debt market for an “extended period”. Also, it will be seen as a bailout of sovereigns by the central bank and discourage painful adjustments in those economies. The decision for the Fed, however, will be far more complicated. Borrowing costs in the US are already at record lows and, again, it is not clear what further easing will intend to achieve. However, the unintended consequences are very clear.

Monetary expansion will naturally push up commodity and asset prices. As a consequence, higher commodity prices will not only have a negative impact on global growth prospects, but will also delay the necessary adjustments in the euro zone and other large economies. Central banks, globally, will have to be very careful with their growth objectives. It is now well established that excessive inflation targeting by central banks was one of the root causes of the asset price bubble, which resulted in the great crash of 2008. Targeting growth excessively may also lead a different set of unintended consequences, but may be equally devastating.