On Saturday morning, the Reserve Bank of India took a number of steps to make more money available to banks for injecting into the economy. These measures will make an additional Rs 2 lakh crore available to banks, which they will hopefully lend to businesses and consumers, thus preventing an economic slowdown. That's the theory. During the past few months, even the most disinterested people have learned the basics of how central banks fine-tune monetary policy. The simplified version is that central banks control the quantity of money that is available in an economy. More money means more growth but higher inflation while less money means lower inflation but less growth as well. Economists tell us that this control system sort of works, most of the time.
It's interesting that the RBI did not see the need for these actions eight days ago when it came out with its credit policy. Perhaps we ought to be alarmed that enough has happened in the past six days that has necessitated the latest actions. The Reserve Bank certainly seems to have developed a new bias for action of the kind that seems to have affected central banks and governments around the world. In the last few weeks, there has been a frenzy of actions from governments and central banks to counter the financial crisis. Almost all this action has taken the form of pouring large sums of money into their economies, generally through banks. The IMF is also stepping into the act, with emergency funds for countries like Hungary and Iceland that are running out of hard currencies.
All this is a little bewildering for the ordinary person who is watching all this while getting increasingly worried about his job or business, as well as any financial investments that he may have made. The view from ground level is that there is a huge global crisis that is going to become much worse. 'Authorities' of various kind are doing a lot of things but none of it is working. I believe this is the crux of the problem. From my interactions with people who are seeing their life's investments distressed beyond belief, I get a strong sense of this 'nothing is working' feeling.
This is what is heightening the sense of panic which has grown completely out of proportion to the actual economic distress. I think the biggest problem is that the panic is itself adding to the distress and thus becoming a self-fulfilling prophecy. Will the panic modify the affect that increased liquidity is supposed to have? The final agents through whom the monetary manipulations of central banks work are human beings. All changes in money supply are eventually intended as inducements to people-individually or as entrepreneurs and managers-to modify their behaviour. The idea is that if more (and cheaper) money is available then they will borrow, lend and spend more. But will they do so even if they are panicked about the future? I'm not so sure. The management of growth vs inflation through monetary policy is clearly not a science but a craft. It works because finally, enough human beings act in a certain predictable way. If something different is affecting that predictability, then the outcome may be different too.