Ban elevator economics

Data for the last 30 years suggest that the most important variable affecting GDP growth is real interest rates

July 5 marked a major event day for the world's economies. The European Central Bank cut rates by 25 basis points, the Bank of England expanded quantitative easing and China surprised everyone with a 31 basis-point cut in its lending rate to 6 per cent, and a cut in deposit rates to 3 per cent. This coordinated monetary easing was conducted both by economies growing at a very slow pace (eurozone and England) as well as an economy growing at the fastest pace in the world, China. The latest industrial production data for China is a growth of 10 per cent, and latest inflation data is at 3 per cent.

Meanwhile, in that other fast-growing economy in the world, India, talk is of animal spirits, decreasing red tape, reducing the fiscal deficit, cutting subsidies, and yes, making India more business friendly. Note the contrast — very few analysts in India are talking of a necessary condition to get India moving, namely a cut in our oversized levels of real interest rates, and everyone in the world outside India is talking of a reduction in interest rates to propel growth back to near normal, let alone normal.

Why is India so different? A large part of the explanation lies in the beliefs of its policymakers, past and present. For example, in the latest policy statement of June 18, the RBI stated: "Our assessment of the current growth-inflation dynamic is that there are several factors responsible for the slowdown in activity, particularly in investment, with the role of interest rates being relatively small. Consequently, further reduction in the policy interest rates at this juncture, rather than supporting growth, could exacerbate inflationary pressures".

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