RBI policy will be based on growth-inflation dynamics

G.R.N. Somashekar, The RBI Governor, Dr D. Subbarao, and the IISc Director,P. Balaram, at a lecture at the Indian Institute of Science in Bangalore on Friday.



The Reserve Bank of India will calibrate policy action based on the evolving growth-inflation dynamics, said the RBI Governor, Dr D. Subbarao, while delivering the M.Ct.M. Chidambaram Chettyar Memorial Lecture on `Economic Crisis and Crisis in Economics` at the Indian Institute of Science, Bangalore, on Friday.



Explaining that on the recovery trail of the global recession, India has been an outlier on two fronts - faster recovery and higher inflation - and moving out of an expansionary monetary policy stance is difficult, he said. According to him, it was a challenge for the RBI in the October-December quarter of 2009 to respond to a hardening inflation situation even as recovery was still fragile?.



Currently, though the service sector contributes 65% of the country`s GDP, Dr Subbarao said policy-makers now realise that the future of the economy depends on developing the manufacturing sector and agricultural sector.



``But it has to be technology-based manufacturing, because we need to compete with the world. We need to improve our productivity, and that`s where technology comes in,`` he explained.



Economic models:



The RBI has its own economic models that have been robust and good for policy calibration, he said. ``We have a mandate for price stability, growth and financial stability,`` he added. Dr Subbarao pointed out that monetary policy transmission in India was flawed for many reasons, including interest rates and Government borrowings. ``But it is improving now,`` he said.



On the criticism by economists that the RBI was behind the curve and on neutral rates, Dr Subbarao said in an economy such as India`s, - a neutral rate is not a static or constant rate?.



Speaking on the economic crisis, Dr Subbarao said there were flaws in the models used by Governments, central banks and economic agents that led to the financial crisis, caused by assumptions that the future can be predicted by extrapolation of past and present trends and that risk follows a normal distribution and does not take into account `black swan` events - low-probability, high-impact events.



Instead of fitting the model to the real world, economists were trying to fit the real world into models, he added.



Economists should be sensitive to the limitations of their models and use judgements to interpret model results, he said, adding that they should acquire a sense of economic history too.



``Policy makers need to superimpose judgement on top of economic analysis,`` he explained.


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