The Financial Framework of India: Monetary Policy of RBI Deconstructed 💸

Part of 1 of 3 - Monetizing the Deficit or printing notes

The God of Money - Kubera

Welcome to part 2 — today what we are presenting to what economics academics, especially in the context of the monetary policy is what we've called Economics 101. In the previous episode, we spoke in terms of the open market operation, which was recently undertaken by the Reserve Bank.

Now, today we are going to talk about another very popular and a very contested and a controversial mayor of the intervention of the Reserve Bank of India in sofa as a monetary policy is concerned, and that is popularly called monetizing the deficit, but the newspapers often write it as printing notes.

Now, before we understand what this is all. We need to understand what fiscal deficit of the government means. Now, government, like any other entity, has its own sources of income, expenditure, its own income, its borrowing its expenditure, and it may also invest, extend loans, which could be recovered. But at the end of the day, if there is difference between your gross income and your gross expenditure, I include your debt service.

So you have to make good to balance your books and to fill that gap. The fiscal deficit, you've got to borrow money from various sources. It could be banks, it could be public, it could be your employees. It could be the reserving of vendor. So the essence is fiscal deficit is a mere of the borrowings, which the government needs to do each.

In order to carry out its projected budget and budgetary responsibilities. Now, government can't borrow from various sources, I said from its own employees. The General Provident Fund resides with the government, and similarly, you can borrow from banks, which is a part of the statutory liquidity ratio.

You can borrow also from the Reserve Bank. So therefore, what is this monetizing of? So borrowing has to be affected by the government, and in this case, the borrowing is directly from the Reserve Me of India. And it is popular as well as in the books of economics described as monetizing the deficit. And as I said, newspaper headlines, they make you believe it is printing notes, increasing the money supply.

Now the former. Governor of Reserving of India recently, MRAM Rajan speaking to or writing his own blog, he said, it is not a magic bullet. It is not something which should create panic At the same time, it is not pania for all the ills. So therefore, there are times when you can monetize the deficit. Now, how do you do that?

You simply borrow from the reserve Bank of. , the money comes from the Reserve Bank of India and goes to the government of India. So therefore, there is no third party in between, no banks, no intermediaries, no nothing, no financial institutions and the Reserve Bank of India may print notes to generate this new money, which goes to government of India.

Now, printing of nodes does not mean by itself. You create. Or that the money is free for government of India. Now, that is a very important aspect, which we need to underline and underscore when the government borrows from the Reserve Bank of India and when it does to monetize the deficit printing of loads, it is not free money.

Let it be very clear. It is alone as good, alone as. borrow from a bank, from the public, from any other entity. So it is a loan from the government of India, which you have to service. There is a rate of interest, there is a , and that money has to ultimately go back over years to the Reserve Bank of India.

So it is not free money. Now, what are the disadvantages and why does it mean pressing a panic button for some. If the inflation is high, if there is already too much money chasing after too few goods and services, and you pump in more money and print more notes to bridge the deficit of the central government, then obviously you will have more money chasing after the same goods and services and would create an inflationary pressure.

But in a scenario like in a covid scenario, Where the demand in the rural areas, low government's own revenues are low. The businesses are not investing. The banks are sitting over money. The interest rates are ruling medium and they're not already high. So therefore, this supply through monetizing of the deficit by the RBI is not going to send wrong signals.

What. is material which is less talked about when monetizing of the deficit is discussed by the pink papers and the other economic journals is okay. Here is the Reserve Bank of India giving money directly from its Coffs by printing notes or otherwise to the government of India. Much more important is what the government does with.

If it is really going to use that money for debt servicing, it is like borrowing from A to pay B. It does not really change the balance sheet, but what is expected is that in such a case where you resort to monetizing of the deficit models as an exception, then a rule you would use that money prudently and prudently to stimulate demand in the rural.

To fund infrastructure projects that would have a kind of a toggling and a triggering effect to reach out to the poorest of the poor in terms of welfare schemes where subsistence is the question. To have schemes like the manga where you have small rural infrastructure projects, which not only pay wages to.

Landless and the unemployed as a guarantee, but also you are able to build small rural infrastructure. So therefore, how the government of India is going to spend that money is also going to send signals. And therefore, as Rajan rightly said, it is not something to be seen as a panic button. At the same time, it is not a magic bullet.

So therefore, depending on the ex, The government can and should resort to monetizing of the deficit by asking the rrb to directly lend and in the process, bridge the deficit and tied and steer the nation towards safer shore. So this friend was a small little talk that we wanted to have on monetizing of the deficit and the parting notice.

It is definitely not free money for government of. It is money. It is a loan which has to be returned and returned with a rate of interest, which is broadly linked with the market rate of interest. Thank you for watching, and I think in the next episode we'll be talking in terms of quantitative easing.

Not much used in India, but quite popular sometimes by the Fed of the United States of America. So stay tuned and keep in.

And if you think these posts are of value to you or could be of value to your friends, please don't hesitate to share, subscribe and comment. Thank you. Stay safe and have a great day ahead and I’ll see you in the final part of the 3 part series.