Save jobs or protect savers? A new monetary policy dilemma

Context: Should RBI increase the interest rate or continue with its accommodative stance? A new model has also been suggested – HANK (Heterogenous Agents New Keynesian). 

Introduction 

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, something new has been for India— Heterogenous Agents New Keynesian (HANK) model. 

What is HANK? 

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 negatively impacted when central banks push down the interest rates. 

• Rationale behind HANK: The central idea behind the HANK model, 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. 

• The HANK model also depends 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 monetization 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.  

• What HANK doesn’t recommend? – HANK, however, does not suggest unrestrained spending for long. This specialised policy comes in handy when the country is witnessing a once in a century crisis. 

Why should RBI continue with its accommodative stance? 

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. 

• Lowest monetary policy rates ever are also justified at a time when the pandemic managed to push the gross domestic product (GDP) to its deepest contraction in the last fiscal year. 

Why should RBI discontinue with its accommodative stance? 

• Impact on pensioners: There are at least 42 million senior citizens in India with at least Rs 14 trillion deposits who have no hedging (risk management) in case of interest rate declines as we have no comprehensive social security.   

Way forward 

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. 

Terms to know 

• Accommodative stance of RBI 
• Fiscal policy  
• Liquidity management by RBI 

Source: Business Standard