RBI says liquidity is
ample in the market, but demand is down. Demand is down due to high inflation
and interest-rates which also restrict supply. There are two ways to match
demand with supply. One way is to bring liquidity and supply down to the demand
level, the way RBI wants to go. And, the other is to increase demand to the supply-level.
Lowering liquidity and supply will further increase inflation and
interest-rates. However if we increase liquidity and supply it will lower
inflation and interest-rate, demand will go-up. If demand and inflation is a
problem, then more liquidity and supply may reduce relative demand which will
also lower inflation and interest rate. The RBI is following the former way,
which may diverge the economy from its long-run equilibrium, because less
liquidity or supply might increase inflation and interest-rate which may
further weaken demand. Everytime demand relative to supply will go down, the
RBI would reduce supply to match demand and the economy would fall in a
downward-spiral, less and less demand and supply will reduce growth-rate. Nonetheless,
if the RBI increases liquidity and supply, inflation and interest-rate will go
down, demand relative to supply will go–up and everytime demand will go up the
RBI will try to increase liquidity or supply to achieve price-stability, full-employment,
and higher growth-rate. Increasing liquidity and supply could lower inflation
and interest-rate, and, will increase demand and growth-rate. Higher interest rate also adds to inflation by
increasing the borrowing-cost. Lower interest rate means high supply and demand.
Monetary and fiscal policies work differently. The latter directly adds to
wages and effective-demand, responsible for inflation which INDIA saw since
2004, while the former was used to control it... Monetary-policy had a very
little room to work, only concentrated on inflation control by tightening
demand instead of increasing supply... Monetary-easing became possible on after
fiscal-consolidation... The crowding-out effect, a long-time issue... When
monetary-policy works market tries to lower prices because of price competition...
But, fiscal-policy makes the government the only player without competition... It
itself decide or play an important role in determining all the prices...
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