Monetary policy needs good data

The Reserve Bank of India’s (RBI) policy rate cut on December 6 took many analysts by surprise.

- RAJESWARI SENGUPTA

It came just after the government reported that the economy was growing at a staggering rate of 8.2 per cent.According to the standard macroeconomics playbook, when an economy is growing so fast, central banks are expected to tighten monetary policy — meaning they raise rates preemptively — to control inflationary pressures and stop the economy from growing too quickly.

This time, however, the situation was different because inflation has been running at less than one per cent. This comfortable price environment gave the RBI the flexibility to lower rates but it does not automatically justify such a move. The core dilemma remains: Why provide further stimulus to an economy that is already booming at an 8 per cent growth rate?

Does this mean the RBI’s policy decision was misguided? Not really. Rather, the rate cut becomes perfectly understandable when viewed through the lens of the policymakers’ primary dilemma: The need to guide the economy while navigating through a thick statistical fog.

Let us begin by examining the gross domestic product (GDP) data itself. Official figures suggest that growth is soaring, far above last year’s estimated growth rate of 6.5 per cent. On the surface, the expansion appears broad-based and robust, with the manufacturing and services sectors each growing at 9 percent.