Adopt multiple indicators to impact credit, Stiglitz tells RBI

MUMBAI: Credit should be the centre of monetary policy, according to Nobel laureate Joseph Stiglitz. He also underscored the need to adopt a multiple indicators approach by the central bank as interest rates are not the only channel but one of the channels to impact credit.

Speaking at RBI on Thursday, Mr Stiglitz, who teaches economics at Columbia University’s Business School and School of International and Public Affairs, said the interest rate signal is no longer adequate in transmission of monetary policy these days, as there is a paradigm shift from the days of classical theories, with change in technology ushering in a change in financial market structures.

Monetary policy objectives of achieving economic growth and stability need to be achieved by adopting a multiple indicator approach. And, the central bank should focus on a plethora of tools. The focus should be on credit markets, he said. “With new technologies, money is not required for transactions, only for credit. Most transactions are not income-generating, but simply exchange of assets. The ratio of exchange of assets to income is not stable. This has changed the
velocity of money.

“This in a way has restricted the effectiveness of interest rates. Like the governments are initiating measures for an all-inclusive growth, the central bank should work towards all inclusive credit,” he said. What affects the level of economic activity is the terms at which credit is available and the quantity of credit, and not the quantity of money itself nor the interest rate on treasury bills or government bonds.

As for interest rate as a signal for monetary policy, Mr Stiglitz said the supply of funds depends not just on the stance of monetary policy, but also banking capital and a firm’s capital, which, in turn, affects the probability of defaults and indirectly the bank’s net worth. Increasing the interest rate beyond a certain level may lead to a reduction in expected return (probability of default increases faster than nominal returns) on account of adverse selection and incentive effects.

The efficacy of interest rate hikes depends on the stage of credit cycle that the economy is in. He cited the case of the US in 1991, when the Federal Reserve Board increased the interest rates when the economy had started cooling and resulted in further precipitating recession.Similarly, interest rate hikes in Indonesia and Thailand further precipitated the Asian crisis.