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Can Monetary Policy Be Inclusive?

In a period of 17 months, the Reserve Bank of India raised bank rates 11 times and now the repo rate is 8% and reverse repo rate 7%. This has caused a furore among industry and trade. Why? This action of the Reserve Bank is reminiscent of the bank rate policy of the Bank of England during the second world war and post-war period. When prices were spiralling, the Bank of England raised bank rates frequently but without any desired effects. Meanwhile, a study in 1938 by Harvard Graduate School of Business on 93 firms and another study by Oxford Economists Research Group in 1939, based on an analysis of 309 firms, failed to provide any strong confirmation of the association between interest rates and investment. The Radcliffe inquiry of September 1957 to March 1958 represents the most comprehensive examination of the question of interest sensitivity of investment. The Committee with the help of the Association of British Chamber of Commerce (ABCC) analysed 3,404 firms by itself and with the help of Federation of British Industries (FBI), 1,595 firms. The inquiries of the former found that only 4% of the firms recorded the increased cost of borrowing as affecting investment decisions, while the latter reported that 6% of them were affected. The insensitivity of investment of movements in short-term rates was explained by the fact that when prices were rising, business interests were buoyant and the ability to pass on such increase in cost prevented the rate of interest from having any significant reduction in the profit margins of business and industry.

On the other hand, common experience is that when foodgrain prices spiral, ordinary consumers cut down non-food consumption expenditure so as to maintain the normal consumption pattern of food items. When they rearrange their expenditures, they become worse off as they have to forgo non-food essentials like health, education, shelter, etc. Therefore, any hike in bank rates which blunts the spiralling prices makes these people better off than before.

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