In his first public appearance after announcing his decision against a second term, Rajan said he would never abandon inflation control to focus on growth, but admitted there is indeed a short run trade-off between inflation and growth.
“In layman’s terms, if the central bank cuts the interest rate by 100 basis points today, and banks pass it on, then demand will pick up and we could get stronger growth for a while, especially if economic players are surprised.
“The stock market may shoot up for a few days. But you can fool all of the people only some of the time. If the economy is producing at potential, we would quickly see shortages and a sharp rise in inflation.”
Rajan said, “We had gotten used to decades of moderate to high inflation, with industrialists and governments paying negative real interest rates and the burden of the hidden inflation tax falling on the middle class saver and the poor.
“What is happening today is truly revolutionary we are abandoning the ways of the past that benefited the few at the expense of the many.
Explaining his rationale behind not cutting the key interest rates to boost growth, Raghuram Rajan said banks charge high rates from big industrialists because of the ‘risk’ that they may not repay and they must support efforts to improve loan recovery for lower rates.
Rajan said that RBI has been “wise to disregard advice in the past to cut more deeply”, while observing that high inflation has burdened middle-class savers and poor with “hidden inflation tax” for decades when industrialists and governments were paying “negative real interest rates”.
Giving a lecture here at Tata Institute of Fundamental Research, Rajan said, “While higher inflation might help a rich, highly indebted, industrialist because his debt comes down relative to sales revenues, it hurts the poor daily wage worker, whose wage is not indexed to inflation.
(With inputs from agencies).