There is more than one way to skin a cat,” goes an old English proverb, which means that there are many ways to accomplish the same task. In central bank-speak, the equivalent would perhaps be: “There is more than one way to effect a soft-landing,” that holy grail of central banks the world over. For, going by their actions, especially in recent times, there is no single path to getting there.
Take the US Federal Reserve that as recently as 31 July opted to stay put (for the eighth time in a row) and keep the Fed funds rate, at which banks borrow in the inter-bank market, at a 23-year high of 5.25-5.50%. Meanwhile, just the day before, the Bank of England (BoE) cut its policy interest rate—its first cut in more than four years—to 5%.
That’s not all. While the decision of the US Federal Open Market Committee was unanimous, the BoE’s monetary policy committee (MPC) had its dissenters. It finally voted by a 5-4 majority for a 25-basis-points cut from its 16-year high rate of 5.25%, with governor Andrew Bailey saying that it would move ahead cautiously, which suggests that the next rate cut would take a while.
In contrast, Fed Chair Jerome Powell is on record that the US central bank must gain greater confidence in inflation moving towards its 2% target before easing policy. Asked whether a September rate cut is a reasonable expectation, Powell told reporters that “we have made no decisions about future meetings.
That includes the September meeting.” In subsequent remarks, however, Powell seemed more open to the idea of a rate cut, saying, “The broad sense of the committee is that the economy is moving closer to the point at which it will be appropriate to reduce our policy rate.”
This is more in tune with his testimony before the US Senate’s banking committee in early July, when he admitted that “in the light of the progress made both in lowering inflation and in cooling the labour market over the past two years, elevated inflation is not the only risk [the US economy] faces,” tacitly suggesting that a policy pivot by the Federal Reserve, or a rate cut, might not be all that distant.
Where does all this leave the Reserve Bank of India’s MPC when it meets later this week? On the face of it, it leaves RBI with the luxury of time. India’s central bank may claim its policy decisions are driven by domestic considerations, and not by the Fed’s moves.
However, past experience of uncanny in-step pronouncements by RBI and the US Fed would suggest otherwise. This is hardly surprising. As the central bank of the world’s most powerful economy, the Fed’s actions have a bearing not just on our own monetary policy but on that of central banks globally.
Relative rates influence capital flows and therefore exchange rates, sometimes posing challenges for the rupee’s managed float. But that’s no reason to follow the Fed blindly. When it comes to the growth-inflation trade-off, we are at a different inflection point compared to the US.
In India, all indications are that inflation will remain high over the medium term while economic growth stays at relatively strong levels. In the US, inflation and employment are both trending down.
So we need to keep a sharp eye on inflation in India even as the US could perhaps shift gears. It is one thing to be informed by the Fed’s decision, but quite another to be driven by it.
