News Release
Lecture by the Governor at the Reserve Bank of India
14 October 1996
This lecture is given in honour of a former Governor of the RBI, Chintaman Deshmukh. In it, the Governor reflects on the broad international consensus that has emerged over the past 30 years on macro-economic management, characterised by an emphasis on stability and sustainability. After periods of demand management in which growth and stability were traded off one against the other, with inflationary results, it is now widely accepted that "a stable macro-economic environment - in which economic decisions can be taken with reasonable confidence that they will not be undermined by violent changes in policy, in response to large economic imbalances - is seen as a necessary condition for growth that can be sustained into the medium and long term".
It would be wrong to exaggerate the change, the Governor says. "It does not alter the fact that growth and employment and rising living standards remain the ultimate objectives of macro-economic policy. Nor does it mean that there is no longer a role for discretionary management of aggregate demand. What it does mean is recognition that there are limits to what can reasonably be expected of demand management." Demand management cannot determine the sustainable growth rate, and that it needs to look beyond the short term if erratic policy changes and damaging economic volatility are to be avoided.
Monetary policy is widely accepted as having the specific role of achieving domestic price stability. Even so, the Governor acknowledges that differences of opinion about detail remain - the definition of price stability; whether a relatively low rate is low enough; the independence of central banks; the merits of inflation versus monetary or exchange rate targets; on the pace of transition to stability.
The contribution of fiscal policy is also explored. "A key consideration is that fiscal policy should be sustainable into the medium and longer term... it is also important that fiscal policy should not place an excessive load on monetary policy to maintain macro-economic stability."
"In any event, it cannot be assumed that inflation will in future erode the real burden of fiscal imprudence as it has in the past, not least because today's more sophisticated markets are liable to impose interest rate penalties more aggressively if they sense a risk of either monetary or fiscal indiscipline."
Assessing the results of the new consensus, the Governor notes that while some countries - the United States and the United Kingdom, for example - have enjoyed low inflation with relatively steady expansion and falling unemployment, others - notably in Europe - have not. In the latter case, it is possible that the drive to meet the Maastricht criteria has depressed output and employment in the short run - but that cannot explain the upward drift in unemployment stretching back over 10-15 years. The explanation for that lies in structural rigidities and the supply side.
The Governor examines supply side policies, and concludes that "the key contribution that public policy can make to improving the sustainable, potential, rate of growth is to promote flexibility and adaptability across the economy as a whole". This is not easy, but has to be attempted. "The unemployed or those living in poverty are unlikely to care very much whether their condition is a result of macro-economic or structural weakness. They simply want relief. I am concerned that if, for whatever reason, stability becomes associated in the public mind with weak growth and high unemployment, then there is likely to be a natural temptation to set the present orthodoxy on one side." "The key elements of today's economic policy consensus - monetary stability, fiscal sustainability and structural flexibility - must all hang together."
The full text of the speech is available from the Public Information and Enquiries Group 0207 601 4878.
