Real interest rate of 2% risks impairing growth: MPC’s Varma
- February 23, 2024
- Posted by: OptimizeIAS Team
- Category: DPN Topics
No Comments
Real interest rate of 2% risks impairing growth: MPC’s Varma
Subject: Economy
Section: Monetary Policy
Interest rate concept:
Interest rates represent the cost of borrowing or the return on saving, expressed as a percentage of the total amount of a loan or investment.
- Nominal Interest Rate = Real Interest Rate + Projected Rate of Inflation
- A nominal interest rate refers to the total of the real interest rate plus a projected rate of inflation.
- A real interest rate provides the actual return on a loan (to the lender) and on a bond (to the investor).
- Nominal interest rates can indicate current market and economic conditions while real interest rates represent the purchasing power of investors.
Context:
Varma at MPC:
- If the potential growth rate of the economy is close to 8%, then the economy is not at risk of overheating in 2024-25.
- A real interest rate of 1-1.5% would then be sufficient to glide inflation to the target of 4%.
- A real interest rate of 2% creates the very real risk of turning growth pessimism into a self-fulfilling prophecy.
- Potential growth rate:
- Potential growth is the rate of growth that an economy can sustain over the medium term without generating excess inflation.
Monetary policy committee (MPC):
- Origin: Under Section 45ZB of the amended (in 2016) RBI Act, 1934, central government is empowered to constitute a six-member Monetary Policy Committee (MPC).
- Objective: Further, Section 45ZB lays down that “the Monetary Policy Committee shall determine the Policy Rate required to achieve the inflation target”.
- The decision of the Monetary Policy Committee shall be binding on the Bank.
- Composition: Section 45ZB says the MPC shall consist of 6 members:
- RBI Governor as its ex officio chairperson
- Deputy Governor in charge of monetary policy
- An officer of the Bank to be nominated by the Central Board
Three persons to be appointed by the central government.
Criteria:
- This category of appointments must be from persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy.
Dual objective of MPC :
- Inflation
- Growth
RBI Deputy Governor Michael Debabrata Patra said:
- Monetary policy must remain restrictive and maintain downward pressure on inflation while minimising the output costs of disinflation.
- Private consumption, which accounts for 57% of GDP, is languishing under the strain of still elevated food inflation particularly in rural areas.
- Inflation has to be restrained to its target for growth to be inclusive and sustained.
- The outlook for the Indian economy remained highly sensitive to inflation risks: High inflation erodes purchasing power, especially for those least protected against the higher costs of essentials like food.
- It is only when inflation subsides and stays close to the target lastingly that policy restraint can be eased.
- Restoring price stability is beneficial for all.