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This proposal has kick started a vigorous debate and that’s very important. I think there’s some merit in what @Sabya_K is arguing in that fiscal and monetary policies have to be on same page. But I feel the diagnosis of the problem needs to be nuanced. https://twitter.com/cafeeconomics/status/1302916558956556288
On the whole debate about lower Potential growth, I don’t think it’s right to pin point one or two factors. I think the new normal after 2008 when global recovery was slow and trade/GDP slowed down was one main reason.
In India’s case inability to manage the post 2008 stimulus withdrawal precipitated the boom bust cycle and deleveraging that hit Capex formation. The attendant financial sector problems were allowed to fester for too long and ensured that traditional mon pol became ineffective.
Moreover till about 2018 both fiscal and monetary policymakers believed that India’s growth growth was solid despite slide in investment demand, weak job growth and rising consumer leverage. So there were data issues as well as focus on wrong variables.
It’s about time we shift focus to job growth, wage growth and investment growth rather than focus on GDP which is an imperfect metric inadequately measured. Without this kind of clarity over objectives, solutions put in place might continue to misfire.
Among solutions I agree that FRBM should be significantly overhauled, inflation targeting needs to be tweaked and automatic debt monetisation should be on the table. I would also suggest capital controls as an additional policy option to be considered.
RBI cannot be expected to finance Govt spending directly or indirectly without worrying about Forex mgmt. Without a clear exchange rate framework this is impossible and in that framework capital controls would be an important tool.
On FRBM I would suggest only a revenue deficit target and a medium term budgeting framework. This would enable better budgeting of capex expenditure and it will be a big win if govt sticks to spending plan every year. That will boost the predictability of budget.
That should be paired with an independent Fiscal council that would vet the annual as well medium term budget estimates and give its opinion. It will be strictly advisory and would not dictate budget. That’s a critical distinction.
On inflation targeting I would only tweak the range, do away with midpoint and emphasise average inflation rather than a point estimate. That way 4% doesn’t become a ceiling and also volatility in inflation due to seasonality is accounted for.
Would suggest RBI automatically monetise debt upto 1% of gdp annually and adjust its forex and bond market interventions around this no and based on its evaluation of business cycle and desired balance sheet growth. That way there’s predictability and also constrained discretion.
I am uncomfortable with giving RBI powers to overtly dictate govt spending. That would be undemocratic and also denies agency to finance ministry to carry out its own assessment. We need people with more domain knowledge in govt rather than depending only on RBI.
Lastly fix the financial sector. Using more capital, privatisation of PSU banks and governance reforms. Without proper plumbing all the tweaks to mon pol objectives and tools will be useless.
