Is Stagflation on the Cards?

The sharp volatility and decline in the value of the rupee, witnessed after 21 May, seems to have ceased. Indeed, the rupee has even recovered somewhat, and both North Block and Mint Street are patting themselves on the back. But frankly, though an unintended consequence, the credit, if at all anyone has to be accredited for “sinking” and then “rescuing” the rupee, would go to the chair of the Federal Reserve (the Fed), Ben Bernanke. The Indian economy, nevertheless, is on the skids, the discovery of “green shoots” of revival by North Block and Mint Street notwithstanding.

In the wake of the financial crisis five years ago, the Fed’s easy monetary policy at first brought down short-term interest rates, but even as these rates remained close to zero, the economy showed little or no response. So “quantitative easing” (QE) was resorted to – a programme to reduce long-term interest rates by purchasing massive amounts of long-term US government bonds. This raised the price of the bonds and thereby sought to drive down long-term interest rates. The banks were thus girded on to sell the government bonds in their kitty to the Fed at the higher prices on offer and take the money, but the question remained as to what they would do with the additional money.