What do the RBI and the Fed have in Common?

Sep 15, 2012

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
The trivial answer here is that both the Reserve Bank of India (RBI) and the US Federal Reserve (Fed) are central banks. But there is much more to it. This week, the Fed announced a new round of asset purchases, or as its known more commonly, QE3.

In the past weeks, the Fed had given indications that they may go down this route of further QE. So it is not a huge surprise that has occurred. The scale of the new round of QE is larger than what many had anticipated, and as a result markets have reacted quite strongly to the announcement.

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Let's go back to our initial question; what do the RBI and the Fed have in common? At first glance, they appear to be at complete opposite ends of the monetary policy spectrum. The Fed aggressively pursues expansionary monetary policy to jumpstart the US economy, despite the risk of higher inflation.

The RBI behaves in the opposite way. Despite falling growth rates in India, the RBI has kept interest rates high in order to bring down inflation. Each approach has its benefits and drawbacks, but is certainly clear that the RBI and the Fed have very different approaches to managing the economy.

But there is one striking similarity between them. When the Fed announced QE3 this week, they mentioned that the US economy was in danger due to a fiscal cliff at the end of this year. Unless US lawmakers reach a deal on the budget, significant tax increases and spending cuts will automatically take place, likely dragging the US back into recession. The gridlock in the US political system means that this is a likely outcome.

And so, the Fed has taken the step to pursue aggressive monetary policy to make up for the fact that fiscal policy is going to push the economy in reverse. And the fiscal policy gridlock is all due to political factors. Perhaps now this sounds familiar.

The RBI has repeatedly mentioned that the government is doing little to help inflation and help the Indian economy. And this is largely due to policy paralysis and inability of political parties to reach agreement. Thus, the RBI's policies are in part trying to compensate for the fact that the central government is not likely to achieve anything substantial.

What the Fed and the RBI have in common is that both are operating in environments whereby fiscal policy is harming the economy. And unfortunately, no amount of central bank action can make up for policy paralysis in the fiscal sphere.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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3 Responses to "What do the RBI and the Fed have in Common?"

Hasit Hemani

Sep 17, 2012

At both the places there are some real donkeys at work. At both the places they take policy decisions that sometimes actually messes up the the things rather than solves it. At both the places the blockheads think that they are running the show but they do not know that economy is a self regulating adjusting complex manifestation which takes into stride even wrong policy decisions. Like our body it requires food and discipline to keep it healthy. But when we indulge ourselves and have a go we suffer and get sick. But somehow it again re-surges automatically. So economy should not be interfered too much.



Sep 16, 2012

Any country should have a stable economic policy. Frequent changes in the policies and laws by the politicians and / or Central Bank would naturally affect the planning of corporate world. We have 5 year Plan system. But 5 year plan guide lines get deviated every year during budget. If we maintain a stable interest rate structure, government can easily stabilise the price structure of end products and thus bring the stability to the economy with a consistent growth rate.
In India because of the present political out look under the guise of 'globalisation' we have permitted FIIs into Indian stock exchanges which has been de-stabilising our economy. All our planning is going to waste basket with the vagaries of FIIs in acquiring control over our corporate world. Let the Government wake up at least now and send out FIIs as INDIRA GANDHI did once during her regime.


Umesh Sharma

Sep 16, 2012

The problem India faces is the Governments inability to give the country good governance in return for the taxes and levies it collects.If there is a sincere attempt to maximize the benefits to the nation by proper utilization of resources instead of frittering them on political gimmicks like subsidies reservation quotas and development plans which have a very low yield.If the Government minds its business with due sincerity there is little required of RBI to control inflation by tight monetary policy or otherwise

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