Towards a well-targeted interest rate policy.
Gurbachan SinghAshoka University
The central bank faces a trade-off while using its interest rate policy for the purpose of macroeconomic stability. So, the policy is not very effective. Also,the prevailing interest rate policy includes a quasi tax-subsidy scheme. In, say, a recession when the central bank lowers the interest rate it gives a quasi subsidy to borrowers and it imposes a quasi tax on savers. So, the policy is redistributive. Also, the changes in interest rates affect asset prices. So, ceteris paribus, it has adverse side-effects for asset price stability. This can, in turn, affect banking stability as well (e.g. the Silicon Valley Bank case in the US). So, the prevailing policy is also blunt besides being non-transparent. Is it possible to have an alternative interest rate policy that is effective, transparent and well-targeted? Yes.