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All eyes are on the Reserve Bank of India’s (RBI’s) monetary policy decision on Tuesday. Many are reckoning that a 25 basis point rate cut is a done deal. The real question is whether it is going to be a 50 basis point rate cut. This column is not going to devote too much of space to this issue because the arguments made by this columnist before the monetary policy meeting of RBI held in April still hold. I had argued then that RBI should use the window of opportunity to cut rates by 50 basis points and move to a neutral stance. I reiterate it now. One of the reasons that RBI did not follow that advice was that it mentioned that the first quarter slowdown in the US economy was likely temporary and that the Federal Reserve would raise interest rates soon, leading to volatility in emerging market economies and asset markets. That fear has receded considerably.

In the US, the first quarter (January–March) gross domestic product (GDP) growth has been revised down to 0.7% (quarter-on-quarter, annualized) thanks to a larger trade deficit than originally estimated. The US—weak or strong dollar—has a policy setting that fosters more consumption, less saving and less production. Hence, it continues to be a source of demand for the rest of the world and runs trade deficits. Regardless of the Trans-Pacific Partnership agreement, the days of the return of Made in America are more remote than India achieving success with its Make in India programme.

What else were the important aspects of the first quarter GDP growth numbers from the US that have a bearing on the growth rates in the rest of the year, hence on the US monetary policy and hence, on the rest of the world? Household consumption of goods (as opposed to services) is rather weak. Indeed, the fact that consumption of durable goods in real terms is weak is an important warning because durable goods are subject to hedonic pricing adjustments. This method of price adjustments understates the increase in their nominal prices of durable goods and thus inflates the real value of their consumption. The price index for durable goods included in the basket of personal consumption goods has declined in the last 15 quarters straight without a break. Yet, household consumption of durable goods is rather weak.

Far too little attention has been paid on the role that hedonic price adjustments have played in the distortion of inflation numbers in the US. This methodology has been adopted with the aim of understating inflation, by making egregious assumptions about households substituting goods whose prices are rising with goods whose prices are stable or falling. In addition, hedonic price calculations make adjustments for quality improvements such that a normal price increase is reversed in statistical indices by taking improvements in quality into account.

Let us look at one example of how the computation of consumer prices is badly distorted by hedonic price adjustments. The Bureau of Labor Statistics index of prices for new vehicles has gone up by 1.14% from January 1997 to February 2015 (146.735 in February 2015 over 144.600 in January 1997). Try telling that to someone who shops for a new car in the US. According to readily available public information, the average new car price in 1997 was $17,000 compared to about $33,000 today. As David Stockman, former budget director under president Ronald Reagan put it, it is hedonics gone haywire.

By squeezing all inflation out of statistics but not in reality, all that the American government has achieved is less inflation-adjusted growth in pensions and lower social security contributions than otherwise. The average worker finds his wages growing more slowly because official inflation is lower while his disposable income based on actual inflation is a lot lower. On the other hand, officially measured inflation being low enables monetary policymakers to pursue looser monetary policy and enrich asset owners for low interest rates foment and nurture asset bubbles.

Coming to personal consumption of services, we note that the household consumption of healthcare services in the US makes a substantial contribution to measured GDP growth numbers. In the first quarter of this year, personal consumption of services contributed 1.1% to GDP growth, even as the overall growth rate was -0.7%. Of that 1.1%, more than half (0.6%) was contributed by consumption of healthcare services. Well, that is not healthy.

How does the second quarter look? Federal Reserve Bank of Atlanta has a nowcast model of GDP growth. Their projection is that in the second quarter, economic growth will be around 0.8%. Sell-side consensus forecast is for a growth rate of 3.0%. They are congenital optimists, even in the face of facts.

What does it mean for American monetary policy? So far, Federal Reserve officials have stuck to the stance that the Federal funds rate would rise at some point this year. It is more likely to be in the last quarter of this year and it will probably be just a quarter-percentage point increase in 2015.

In other words, the taper tantrum of 2013 is no excuse for RBI not to cut interest rates on Tuesday.

V. Anantha Nageswaran is co-founder of Aavishkaar Venture Fund and Takshashila Institution.

Comments are welcome at To read V. Anantha Nageswaran’s previous columns, go to

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