Indian and pessimistic. That would break the system

Indian Politician’s Dilemma


2014 general elections!

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With a blast, NDA government started
its term with huge expectations of growth from public, as was promised
thousands of times in manifesto. Gujarat had been already set as a milestone of
development over the past decade, a significant credential to make people
believe in the government to maintain its credibility. The most important
thing, has to be introduced here, the central bank has an inseparable role with
government to enhance any country, so does RBI.

In the legal course, professors say
– “It is my job to be the no man and your job to be
the yes man”. A leader by nature is an optimist. He sees
a rosy path. His counsel by nature should be a pessimist. He should point to
the thorns.

The reason why we have two
different roles – RBI governor and Finance Minister – to manage the economy is
essentially along the lines. Like yin and yang, tester and developer, they
complement each other.

RBI governors like all bankers and
lawyers are selected to be very conservative. They have to look for the worst
case. When the bankers party, things collapse like it happened in 2008.

On the other hand, an executive
cannot be that sullen and pessimistic. That would break the system as the
gloominess would catch on. He/she has to be the head cheerleader to get the
system going. They have to find a smile even when the situation is deadly.
Because, they are the morale boosters. We have already seen the effects of
having a sullen economist as a Prime Minister for 10 years. While he was smart
about economics, he was not able to cheer or guide the economy.

This graph shows a relationship
between growth, in terms of GDP growth rate and inflation, in terms of CPI
growth rate.

Major Reasons why Economic Growth and Inflation Control can’t go

When inflation is high, interest rates are hiked.
The reason being, a high interest rate will discourage additional borrowings.
This shall reduce the amount of money people have in their hands to spend.
Traditional economic theory suggests that as demand falls, prices also fall.
Thus, RBI aims to control inflation by increasing interest rates. When economic
activities falter, a cut in interest rates is required. This is because
companies need to borrow in order to invest in new projects. A fall in interest
rates reduces cost, thereby increasing profitability. This encourages
borrowing, which in turn, helps fuel the economy.

A high interest rate is detrimental to growth.
Companies discontinue expansion or growth plans due to high interest rates.
They are forced to cut costs to maintain profits. This passes across the
economy including the labor market. A low interest rate can cause a rise in
inflation. This is a result of more money in the system. This leads to an
overall price rise as demand increases. A high interest rate controls inflation
but retards growth. In contrast, a low interest rate is beneficial for overall
economic growth. Therefore, both economic growth and inflation cannot be
targeted together.


A macroeconomic policy ideally should aim at high
economic growth accompanied with low levels of inflation. However, in
reality, accomplishing both a low inflation rate and a rising economic growth
is never possible. However, low inflation rate does not indicate slow economic
growth. In situations of excess money, consumers begin the process of bidding
which results in escalation of the cost of goods. In the case of Indian
economy, a number of studies failed to establish any conclusive relationship
between inflation and economic development. Low level of inflation is
advantageous for development, but once inflation goes below a certain level it
retards economic development. Therefore, it is mandatory to perform inflation
control at an acceptable level to promote optimum economic growth.

You don’t want an economist to
lead the country nor a politician to govern the RBI. When Raghuram Rajan is
pessimistic and Narendra Modi is optimistic, it means both of them are doing
their jobs. They differ because one is looking at the worst case and the other
at the best case.