I Do What I Do

by Raghuram G. Rajan

There are a number of points here that need elaborating. First, are we choosing to tackle inflation at the expense of growth? Most people believe there is a short-run trade-off between growth and inflation. By raising interest rates, the RBI causes banks to raise rates and thus lowers demand; firms do not borrow as much to invest when rates are higher and individuals stop buying durable goods against credit and, instead, turn to save. Lower demand growth leads to a better match between demand and supply, and thus lower inflation for the goods being produced. Relatedly, if lower rates generate higher demand and higher prices for goods, people may produce more of those goods, believing that they are getting more revenues. But because all goods are going up in price, high inflation reduces what they can buy out of the revenues. Following the saying, ‘You can fool all the people some of the time’, bursts of inflation can generate growth for some time. Thus, in the short run, the argument goes, higher inflation leads to higher growth.