Monetary policy effectiveness to decline due to supply shocks, says chief economic adviser

Chief Economic Adviser V. Anantha Nageswaran stated on Friday that in a world becoming more sensitive to supply-side disruptions, monetary policy tools, such as changes in interest rates, may become less effective in controlling inflation. According to a report by Business Standard, he made these remarks during the 9th Annual Food Systems Dialogue.

Nageswaran added that fiscal and other public policy measures will become more important as raising interest rates will not solve supply-driven problems. He warned that if anything, it could prove to be counterproductive. Amid persistent supply-side issues, countries will have to employ all possible flexibility regarding inflation targeting frameworks.

He noted that very few countries have been able to meet their inflation targets since 2022. Therefore, while this framework will remain, countries will have to exercise creative freedom with it as they have no other option.

Supply chain disruptions following the Russia-Ukraine war since February 2022, and subsequently the crisis in West Asia, have led to a major surge in prices globally, especially for energy. To keep inflation in check, major central banks of the world, including the US Federal Reserve, have raised interest rates.

The Reserve Bank of India also raised the repo rate by 25 bps to 5.50 per cent last month to control inflation, for the first time in nearly four years. In October 2024, retail inflation was 6.25 per cent, crossing the central bank's upper tolerance band of 6 per cent. This is the first time in two years that retail inflation has crossed this limit, while the central bank is mandated to keep inflation between 2-6 per cent.

Citing some reports, Nageswaran said that supply shocks will dominate the world for the next 25-30 years or more. He stated that when countries weaponise supply chains and utilise natural waterways and other choke points, the ability to solve these problems merely by decreasing or increasing interest rates will no longer be practical.

In such a situation, Nageswaran called for restoring agriculture as a primary driver or engine of economic growth. Additionally, he expressed concern that the emergence of Artificial Intelligence and restrictions on immigration in various countries could slow down the pace of job creation in the service sector.