RBI suggests mix of fiscal, monetary policies to mitigate economic downturn

Mumbai, May 24 (FN Agency) A Reserve Bank of India (RBI) study has advocated a mix of fiscal and monetary policies to mitigate economic downturn, saying demand side channel needs to be complemented with a conducive monetary transmission mechanism from the supply side. Referring to the 2009 crisis, the study by Development Research Group (DRG) on ‘Risk Premium Shocks and Business Cycle Outcomes in India’, said that at the micro-level, the interest rate spread, attributed to risk premium on loans, increased in response to a rise in loan defaults during the post-2009 period.

Also, the credit growth was found to be negatively associated with the loan default rate, indicating that a shock to the borrowing sectors has a significant negative impact on credit growth, it added. On the policy interventions to deal with the crisis, the study said, ‘our policy experiments reveal that an expansionary policy mix of fiscal and monetary policies may perform better than the individual-level intervention of expansionary monetary or fiscal policy to mitigate the economic downturn as the demand side channel can be complemented with a conducive monetary transmission mechanism from the supply side’. DRG has been constituted as part of RBI’s Department of Economic and Policy Research to undertake quick and effective policy-oriented research backed by strong analytical and empirical basis on subjects of current interest.

The study co-authored by Shesadri Banerjee, Jibin Jose, and Radheshyam Verma investigates the dynamic effects of financial shocks on the business cycle. RBI has also published another DRG study titled, ‘Threshold Level of Inflation – Concept and Measurement’. It is co-authored by Ravindra H Dholakia, Jai Chander, Ipsita Padhi and Bhanu Pratap. The study examines the concept of threshold inflation and defines it as the long-run equilibrium rate of inflation that maximises the steady state growth within the relevant range of values, it said. The empirical findings of the study broadly confirm higher threshold inflation and higher growth in emerging market economies than in advanced economies.