In this article, Niranjan Rajadhyaksha takes a closer look at financial and business cycles in India. He analyses the policy implications of India's 12-year financial cycle, compared to the typical 5-year business cycle.
"One of the most important policy lessons in recent years is that economic stability is no guarantee for financial stability. A country with low inflation, steady growth and a reasonable current account deficit can still experience financial stress. The most costly example of this is what happened in the US in the first decade of the new century. The economic stability during the final years of the Great Moderation masked deep financial fissures that would later lead to the near-collapse of financial systems in many large economies—and subsequently a long recession."
He concludes by drawing out the policy implications.
"The renewed interest in financial cycles across the world is welcome, especially since financial markets have only grown in importance. There is an important implicit lesson for policymakers from the recent research showing that financial cycles are not synchronous with business cycles—and have longer average durations. The same policy tools cannot be used to both target inflation, as well as maintain financial stability.
That perhaps explains the growing interest in macroprudential policies to maintain financial stability so that central bankers can use interest rates to manage the real economy. Such macroprudential policies are still largely untested, but the underlying principle is important. Any move to curb financial exuberance using macroprudential tools tends to be unpopular in financial markets—be it the curbs on bank lending to real estate imposed by RBI under Y.V. Reddy, or the later decision to put weak banks under preventive corrective action during the tenure of Urjit Patel."
Read the complete article here.