ExplainSpeaking: Common thread between the IMF’s World Economic Outlook, RBI Monetary Policy, and the origins of the Nobel Prize in Economics


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Dear readers,

The Indian economy has witnessed a whole series of important news events over the past week and it has a busy schedule this week as well.

Finally, the government was able to find a buyer for Air India, the debt-ridden and loss-making national carrier. The deal has several implications not only for the government and the successful bidder – Son of Tata – but also for the economy in the broad sense.

Another slightly comforting news was that the rating agency Moody’s changed the “outlook” for India’s sovereign rating from “negative” to “stable”. Readers should note that Moody’s did not change India’s ratings as a bond issuer; which continues to be the lowest investment grade (Baa3). But the “outlook” has improved. Of the three major rating agencies – Standard & Poor’s, Moody’s and Fitch, which all place India in the lowest investment grade – only Fitch maintains a negative outlook.

Put simply, these ratings inform global investors how safe it would be for them to lend money to the Indian government – and, by extension, Indian companies. A low rating, like India has done, implies that investors would demand higher rewards (or charge higher interest rates) to offset the higher risk of lending to the Indian government or an Indian company.

“Outlook”, on the other hand, basically refers to the chances that a country’s rating will worsen or improve. A negative outlook last year meant India’s rating would deteriorate further. A “stable” outlook is therefore an improvement and suggests that Indian government finances are improving. This improvement also appears to reflect the improvement in the state of the underlying economy.

However, for its part, Fitch Ratings cut India’s economic growth forecast to 8.7 percent for the current fiscal year while maintaining the negative outlook on Indian bond issuance. There was good news from Fitch and he raised India’s GDP growth projection for fiscal 23, that is, next fiscal year, to 10%.

Finally, there was the RBI’s monetary policy, which proved to be according to widely expected lines. Most analysts assumed that the RBI would maintain the status quo on the repo rate, which is the interest rate the RBI charges commercial banks when it lends money to them. In times of weak economic activity, as it is now, the RBI keeps the repo rate low to encourage banks to create credit – or extend new loans.

The only problem has been that these are also the times when inflation was quite high. High inflation usually forces the RBI to do the opposite – raise repo rates to cool economic activity. But as ExplainSpeaking has written many times over the past year, RBI has prioritized growing GDP while allowing prices to stay fairly high.

The reason is simple: the RBI is still concerned about resuming growth in India. The RBI governor spoke in metaphors, but its meaning was clear to all when he said that the RBI “didn’t want to tip the boat” as it approached shore and that in fact there was also had a trip beyond reaching the shores. In simpler terms, the RBI does not want to raise interest rates or reduce “liquidity” (or the money available in the banking system to make new loans) too soon or too abruptly for fear that it will hurt the bank. India’s nascent economic recovery.

This choice of the Indian central bank is at the heart of a global debate which is undoubtedly the reason why the so-called Nobel Prize in economics – which should be announced later today – was born.

But first the global debate on the growth-inflation trade-off.

On October 12, the International Monetary Fund will release its latest World Economic Outlook. The IMF publishes this report twice a year – in April and October – as well as regular “updates” on this outlook. Read this article to understand what the IMF said exactly one year ago in its Outlook for October 2020 and this one to understand how things were in the July update this year.

A major concern this time will be the rise in inflation in several countries. “Since the start of 2021, headline Consumer Price Index (CPI) inflation has increased in advanced and emerging market economies, driven by stronger demand, input shortages and the rapid rise in commodity prices, ”indicates the latest IMF PEM. “Prolonged supply disruptions, commodity and housing price shocks, longer-term spending commitments and a de-anchoring of inflation expectations could lead to significantly higher inflation than expected in the reference. Clear communication, combined with appropriate monetary and fiscal policies tailored to specific country contexts, could however prevent ‘inflationary warnings’ from upsetting inflation expectations, ”says the IMF in one of the main WEO chapters of this review. year.

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Now on to the more intriguing part: How does a central bank’s concerns about inflation relate to the origins of the Sveriges Riksbank Prize in Economics, which is mistakenly called the Nobel Prize? economy.

The first thing to know about this award is that Sveriges Riksbank is the central bank of Sweden and it is the Riksbank money – the 10 million Swedish kronor or Rs 8.6 crore all that – that is distributed.

In their fascinating book, “The Nobel Factor: The Prize in Economics, Social Democracy, and the Market Turn”, Avner Offer and Gabriel Soderberg detail the story of the birth of the Nobel Prize in Economics.

Here is the gist.

The Swedish central bank launched the award in 1968 with the aim of undermining the dominant narrative of the political economy of a social democracy. In the post-war scene, Sweden had seen the rise of social democracy – a political ideology that believes in imposing heavy taxes to fund a large welfare state. But one of the essential conditions for achieving the goals of social democracy such as full employment, general and affordable housing, etc. was to have low interest rates in the economy. Low interest rates were needed to bring down the cost of government borrowing. This, in turn, necessitated depriving Sweden’s central bank of its independence. The book details the fierce battle between Swedish Prime Minister Tage Erlander and Per Åsbrink, who was chosen by the Prime Minister to take the helm of Sveriges Riksbank. Even though Åsbrink was in the ruling party, once he joined the central bank his views began to change quickly and he began to see the evils of government policies that kept interest rates artificially low.

Things came to a head in early 1957, two years after Åsbrink’s appointment. “In January and February 1957, the Social Democratic government struggled to finance its housing program in the face of credit rationing from commercial banks. A higher interest rate would have appeased the banks, but housing would cost more. In the standoff, the bankers seemed to gain the upper hand. A credit crunch could split the ruling coalition and split the Social Democratic Party. The Prime Minister was determined to fight. Åsbrink relented and bought the government mortgage. But on July 10, 1957, he unleashed a “coup”. Without consulting ministers, he persuaded the Riksbank board to cut government borrowing and increase the bank rate by one percent. This triggered an acute political crisis. It was at the wrong time: the coalition with the Agrarian Party was fragile, and the delegate of this party to the board of directors of the Riksbank had opposed the increase.

Unsurprisingly, “the Prime Minister was furious at Åsbrink’s ‘stupidity’; the government had “suffered a very serious loss of prestige”, write the authors.

“The Åsbrink coup d’etat grabbed the headlines for several days and thrilled the opposition. The coalition partner (the Agrarian Party) feared that this would harm its voters. Opposition newspapers wrote that the government itself was responsible for creating a “sick economy” that needed this drug. The socialist dream of low interest rates had gone up in smoke. Another wrote that Åsbrink had “proven itself” and had shown “that the central bank is not an annex” of the finance ministry, “say the authors.

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Either way, while rejecting Åsbrink was dangerous, the ruling political establishment managed to humiliate Åsbrink. By 1958, the PM had regained control. “For several years after, interest rates haven’t gone up, and this governor will never step out of line again. Further reprisals followed. The central bank drew its income from seigniorage, the interest on bonds it bought from the government with the money it created. Higher interest rates meant that the bank’s profits from government loans were paid by Swedish taxpayers. The bank remitted a small sum each year to the Treasury and kept the rest in a special account, which constituted a large stock of capital. The one percent hit had produced an injection of revenue, but the Treasury moved quickly to cut it, increasing its share of the take by five.

According to the authors, the launch of the Sveriges Riksbank Prize in Economics was a way for sbrink to return to the dominance of the Social Democrats while claiming to be the patron of science. The authors argue that the Nobel Prize in economics was used to oust “left” economists and promote those who believed in the market.

Indeed, whether or not we agree with the authors’ analysis, it is clear that the independence of a central bank, as well as its choices, are often deeply political in nature.

Who do you think could win the Nobel Prize in economics this year? Write to me at [email protected]

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