UNCERTAINTY UPENDS MONETARY POLICY

Central bankers are most concerned with radical uncertainty, making it nearly impossible to assign probabilities to future outcomes. RBI faces a similar situation as US tariffs muddy the inflation and growth trajectories.

- DEEPAVASUDEVAN

Monetary policy is about making decisions about future interest rates and money supply on the basis of past data. But the past few months have been a period of unprecedented uncertainty even for seasoned policymakers in India, especially when it comes to determining the direction of the central bank's key policy rate.

Uncertainty because of the US's steep tariffs on Indian imports and other global and domestic factors have made it tough to predict the trajectory of inflation and India's economic growth. This complicates deciding on whether to ease, tighten, or maintain the rate.

RADICAL UNCERTAINTY

Central bankers are most concerned about radical uncertainty, which makes it nearly impossible for them to assign probabilities to outcomes.

For instance, it is impossible to estimate what the US tariff on Indian goods would be by the end of 2025. Assigning probabilities to a range of possible tariff rates would only be guesswork. Similarly, it would be difficult to make effective policy decisions if India's GDP growth is equally likely to be 5% or 8% Losing the ability to forecast with reasonable accuracy hits at the very core of policymaking.

The global financial crisis of 2008 is a good example of high economic uncertainty. As the crisis unravelled over several months in 2008 and 2009, it became harder to quantify its impact on India's growth. That can be seen in the changing growth predictions of the Reserve Bank of India's survey of professional forecasters.