The reasons for the rate cuts by the central banks of India and Europe could not be more different, although each region faces economic problems. Each decision shows the weakness of rate cuts as a means to stimulate gross domestic product (GDP). The trouble in Europe is related to lack of inflation. In India, the fear of inflation abounds among central bankers. The next few quarters may tell which approach is less powerful.
The Reserve Bank of India cut its benchmark rate by 25 basis points to 7.25%. The lowering is the third this year. The central bank commented as it took the action: ”The balance of risks stemming from the Reserve Bank’s assessment of the growth-inflation dynamic yields little space for further monetary easing.” But the plan comes just after the World Bank cut its India GDP growth forecast for 2013 to 2014 to 6.1%, down from a 7.0% estimate at the end of last year.
India is caught on the horns of a dilemma not unlike that China has faced off and on since the start of the global recession. Inflation has been a problem for decades. Slow growth is a more recent one. India cannot afford to let either problem to get out of hand. However, central bank policy may be useless as a means to rekindle growth.
The European Central Bank (ECB) also cut rates by 0.25%, but to 0.5%, with the goal to help drag businesses and economies throughout most of Europe from a second recession in less than six years. The recession already has caused negative GDP growth in several nations and helped push unemployment into double digits in some. The situation in the region remains so desperate that ECB President Mario Draghi said, “There are several unintended consequences that may stem from this measure. We will address and cope with these consequences if we decide to act. And we will again look at this with an open mind and we stand ready to act if needed.” Perhaps the ECB rate cuts are not over.
The recent use of interest rates by central banks to address inflation and growth has been as widely discussed as any other government-based activity in the world. Much of this discussion has revolved around decisions by the Bank of Japan and Federal Reserve. However, the actions in India and by the ECB may be more important, because of what is at stake.
The balance between rates and inflation on one hand and stimulus in economies with almost no inflation on the other shows how the supposed power of central banks can be used. It also may show how little leverage these banks have. Agencies like the International Monetary Fund and World Bank continue to revise GDP growth lower in India and Europe. The agencies obviously believe central bank activity means nothing.