The policy rate tightening has had a significant negative impact on inflation expectations on the real economy.
The cumulative interest rate hike of 2.5 percentage points by the Reserve Bank of India (RBI) from May 2022 has negatively impacted headline inflation by 1.60 per cent. This has been said in a paper written by senior RBI employees on Monday. According to PTI news, the paper, written by Deputy Governor Michael Patra, Indranil Bhattacharya, Joyce John and Avnish Kumar, said that the increase in the policy rate has stabilized inflation expectations. Due to this the overall demand has been controlled.
The paper does not represent the views of the central bank
According to the news, while the RBI paper clarifies that the paper does not represent the views of the central bank, the study on monetary policy transmission found that monetary policy changes affect short-term interest rates more than long-term rates. It said the macroeconomic impact of monetary policy on aggregate demand and inflation indicates that the 2.50 per cent hike from May 2022, working through different channels of policy transmission, would have a positive impact on aggregate demand by Q2 2024-25. And contributed negatively to headline inflation by 160 bps.
Higher interest rates had no impact on growth
It is worth noting that in the past, top RBI officials have denied that higher interest rates have had any impact on growth. Earlier questions have also been asked in some quarters as to what impact monetary policy might have on inflation when driven by supply-side factors. The Reserve Bank of India’s letter released on Monday argued that the tightening of policy rates on the real economy has seen a significant negative impact on inflation expectations.
Policy rate hike effectively stabilizes expectations
The paper states that the relationship of the policy rate to inflation expectations shows that an increase in the policy rate effectively stabilizes expectations. It said that anticipated policy changes have no immediate impact on long-term rates, but policy surprises significantly affect all market segments and durations. It detailed that policy surprises have a relatively small but significant impact on exchange rates and equity prices.
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