In holding the repo rate unchanged at 6.5%, the Reserve Bank of India signalled that the worst phase of the current inflation is over. Indeed, retail inflation has softened considerably. But the RBI has recently indicated that inflationary pressures have adversely affected private consumption and capital formation in the economy. The real purchasing power of consumers gets squeezed when prices of important commodities such as food, fuel, and manufactured consumer goods increase. With consumer demand falling, manufacturers are hesitant to increase capacity in their production units, expecting inflation to continue in the near future. Hence, private investment stagnates. Obviously, the growth rate of the gross domestic product then slows down. The only instrument that the RBI then has to effectively control inflation is the policy interest-rate. Price stability is of utmost importance in facilitating high rates of economic growth. However, even if price stability does occur, it would not necessarily lead to higher growth. The stability can occur only at a high level of the interest rates. The level of prices will be high too. The consumers and the producers who wish to borrow funds in financing expenditures will find the cost of credit forbidding. Cheap liquidity and low cost of funds might have led to high inflation in the first place. Now, lowering interest rates might lead to inflationary expectations building up all over again in a cyclical fashion, ultimately leading to rising prices.

Promoting economic growth while ensuring price stability has been the most important trade-off that any central bank has to confront. In developed economies, where the level of activity usually hovers around the full-capacity mark, controlling prices gets priority over accommodating economic growth. In an economy like India’s, boosting growth is of equal significance. Unlike the assertion in the RBI report, the trade-offs will not go away. A deep uncertainty rules economic markets, the global environment, and international geopolitics. Shocks may come from black swan events. The lessons of the financial crisis of 2008 and the financial impact of the more recent pandemic are still not fully comprehended. Therefore, price stability cannot be guaranteed over a reasonable span of time. Perhaps that is the reason why despite claiming that inflation has plateaued, the RBI does not seem to signal that a reversal of interest rate increases is on the cards soon. The pause in rate movements might continue till the next challenging trade-off surfaces.