Save jobs or protect savers? A new monetary policy dilemma

The new Heterogenous Agents New Keynesian model suggests that interest rates can be kept low for the greater good.

The extraordinary accommodative stance of the Reserve Bank of India (RBI), which the monetary policy committee (MPC) members say should continue for as long as necessary to nurse back durable growth, is also bringing new monetary theories into the equation.

While the world is still debating whether modern monetary theory (MMT), which encourages governments to spend without having any meaningful fiscal constraints, should be the norm, RBI’s executive director Mridul Saggar proposed something new for India — Heterogenous Agents New Keynesian (HANK) model.

In simple terms, the model suggests that interest rates can be kept low for the greater good.

While a section of depositors does get affected, not “all savers may necessarily be worse off when central banks push down the interest rates”.

The central tenet of the HANK model, as Saggar argued, is that by increasing demand with monetary expansion, firms would ramp up production.

This would improve their survival rate amid a deep shock like the pandemic and protect jobs that would eventually push more wages and salaries in the hands of households, most of whom may get compensated for a drop in their interest incomes on saving.

“With a large proportion of low income and other liquidity constrained households in India, these indirect second-round effects could turn very significant.

"Furthermore, low interest rates create space for fiscal action in support of growth," the RBI executive director argued.

The HANK models also depend on fiscal policy to address part of the price stability concerns, traditionally the main job of a central bank.

The central bank on its part can do many things – it can keep interest rates low, enhance liquidity, or even do direct or indirect monetisation for the government to help it spend more.

This helps growth, generates demand, and can give rise to inflation.

The government then formulates tax policies that redistribute income to people who are in dire need.

The models, however, do not suggest unrestrained spending or continuing with loose policies for long.

This specialised policy comes in handy when the country is witnessing a once in a century crisis.

Saggar said eventually there would be a need to consider the policy trade-off between leaving the policy rate unchanged and “correcting it at some point for the negative real rates that have persisted for a spectrum of interest rates thus taxing savers.”

There are arguments in support and against the theory, and economists locally are also no exception.

A continuation of RBI’s accommodative stance is “necessary in the backdrop of the second wave and to help support a sustainable recovery through lower rates and easier financial conditions,” said Gaurav Kapur, chief economist of IndusInd Bank, adding that the lowest monetary policy rates ever is justified when the pandemic managed to push the gross domestic product (GDP) to its deepest contraction in the last fiscal year.

Keeping interest rates stable even with rising inflation would help deal with the massive economic shock, and would reinforce an expansionary fiscal policy stance, according to Kapur.

Even with 9.5 per cent growth this fiscal year, the economy would have just grown by 2 per cent in two years, and this merited continuation of growth-focused policies, Kapur argued.

However, punishing the pensioners may not be desirable, argued Soumya Kanti Ghosh, chief economic advisor of State Bank of India group.

“There are at least 42 million senior citizens in India with at least Rs 14 trillion deposits who have no hedging in case of interest rate declines as we have no comprehensive social security.

"Thus, it’s a case of the trade-off between have-nots and senior citizens and not an easy debate to settle,” Ghosh said.

The interest rate component can be adjusted in the case of people who are not solely dependent on interest income.

For example, alternate financial savings avenues such as equity markets participation are getting popular.

But they do not ensure the safety of the principal and are therefore not desirable to the senior citizens.

Ghosh’s report showed that indeed people are divesting towards other investment avenues, partly compensating for the low interest income.

The number of individual investors in the market has increased by 14.2 million in FY21.

Furthermore, another 4.47 million retail investor accounts have been added during the two months of this fiscal.

Also, the share of individual investors in total turnover on the stock exchange has risen to 45 per cent from 39 per cent in March 2020.

Photograph: Francis Mascarenhas/Reuters