Call it the Great Unlearning. In the wake of the 2008-09 crisis, much of the post-war macroeconomic policy consensus is being questioned, if not its underpinnings. This changing outlook is partly amusing (especially in the Indian setting) and partly serious.
Much of the policymaking success of the West rested on the Great Moderation. This entailed a sect of core, unshakeable prescriptions that were implemented successfully: low and stable inflation, a stable gap between real and potential output, primacy of monetary policy over fiscal policy, a limited role for discretionary fiscal policy and independence of central banks.
Illustration: Jayachandran / Mint
The key here was low and stable inflation. This delivered a zero output gap (never mind Japan) and this was held to be the best possible outcome, given the imperfections in an economy. This low average inflation corresponded to a lower average nominal interest rate. There were some murmurs about lack of manoeuvre for monetary policy: In an external shock situation this meant that central banks could only cut interest rates by a few percentage points, the limit of a zero percent nominal interest rate meant a limited room for action.
Now the costs of low inflation, the lack of attention on financial structure and the role of financial innovations on macroeconomics are being questioned. In an International Monetary Fund (IMF) Staff Position Note, Rethinking Macroeconomic Policy, economists Olivier Blanchard, Giovanni Dell’Ariccia and Paolo Mauro have questioned all this, and more.
Higher inflation targets, the importance of countercyclical fiscal policy and the importance of financial intermediation have all been highlighted. The authors have also carefully built a case for higher inflation targets: A 4%, instead of the normal 2%, inflation rate may provide much-needed space to monetary authorities to safely escort an economy out of a crisis situation.
Are there lessons in this debate for India? The first and foremost is: avoid hubris. It makes no sense to say, “See, they are seeing the logic of what we are doing”. If India is indulging (yes indulging) in reckless fiscal expansion, it should not be held as an example of learning the right lesson from the Western experience. Why? Because India did not go through the trajectory taken by the West: We never experienced the Great Moderation. It is only in the last five or six years that we have seen steady growth, but that has come along with bouts of high inflation. We refuse to see the costs of that inflation. Western reasons for seeking higher inflation should not be compared with our experience.
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