India’s inflation rebounded in February, but was still benign enough to support calls for the

central bank to lower interest rates at next month’s monetary policy meeting.

Consumer prices rose 2.57 percent last month from a year earlier, the Statistics Ministry said in a
statement on Tuesday.

Inflation has slowed sharply since last year because of a fall in food prices, and remains well
below the Reserve Bank of India’s 4 percent medium-term target. The central bank is forecasting
inflation of 2.8 percent in the January-March quarter
Modi, M., Sharma, S., & Kar, T., Beniwal, Vri (2019). Bloomberg - India´s Inflation Quickens as Focus Shifts to
April Rate Cuts. Retrieved from https://www.bloomberg.com/news/articles/2019-03-12/india-s-inflation-quickens-
as-focus-shifts-to-april-rate-cut

This article is about how the Indian central bank may lower interest rates as a result of a constant
drastic fall in the inflation rates as, even after a 2.57% growth, it isn’t enough to reach the 4%
medium-term target.

Interest rates are percentage charged on the total amount you borrow or save. ("What are interest
rates?", 2019), lowering interest rates implies that it is cheaper to borrow and less profitable to
save, therefore lowering interest rates encourages consumption spenditure and investment, two
of the components of the aggregate demand of a country, the amount of total spending on
domestic goods and services in an economy. ("Aggregate demand and aggregate supply curves",
n.d.)

Right now, India’s economy is equilibrium at the long run at Pl1Y1 as the article says there
was a 2.57% growth from the previous Pl1Y1 level. However that has not been enough to
reach the target so, after interest rates are lowered, investment and consumption should rise
and so should India’s aggregate demand there should be a shift to the right in the AD1 curve
AD1→AD2, which, in the short run will increase in output from Y1 to Y2. Consequently, we
can see that the economy has grown from Pl1Y1 to Pl2Y2 achieved equilibrium as well.

In the same train of thought, there is a visible rise in the overall price level of the economy
from Pl1→Pl2 and the economy has grown from Y1→Y2 which is the result of an increase in
the rate of inflation, the rate of increase in prices for goods and services. ("Q&A: What is
inflation?", 2014). So, the economy will be experiencing an inflationary gap as, the economy is
now at an equilibrium at a level of output greater than the full employment level of output.

Firms are likely to react to the rise in consumption by producing and selling more, which could
mean they may need more infrastructure and workforce and, this could in turn, reduce
unemployment level.

According to the new classical perspective, this is only possible in the short run and, possible
ways to increase output in the short run is to pay existing workers overtime as, as the economy
was at full level of output, there are no unemployed resources, which means companies are
competing for scarce resources and prices are likely to rise once again.
This increase in price level means that all prices in the economy have risen and firms are pushing
up the price on factor of production in order to make their products. So, this means there must be
an shift in the short run aggregate supply from SRAS1 to SRAS2 as, even though firms are
supplying a higher level of output, the high cost of the factors of production result in no real
gain, reducing real output from Y2 to Y1. As a result, real output is once again at full
employment level Y1 but, at a higher price level, Pl3.

Therefore, in theory, this expansionary monetary policy should solve India’s current inflation
short, reaching the 4% and maintain a stable inflation rate. However, this policy could also
depreciate the indian rupee (INR) in the international market at it is not attractive to save money
in India as a better rate of return could obtained in another country, thus lowering the demand for
INR and lowering it’s value, which will make India’s exports more attractive and competitive,
once again increasing another component of AD, net exports (X-M). However, this will also
increase the price of imported commodities with low elasticity, like crude oil. Yet, if exports are
more profitable, then the effect of costly imports may be outweighed. ("South Asia :: India — The
World Factbook - Central Intelligence Agency", n.d.).

Additionally, when interest rates reach a point where they are too low, banks usually won't have
a high reserve of money and, as their profit from borrowing is not as attractive so, they tend to
lend loans only to high credit borrowers with assets to serve as collateral to their loans. This
makes it harder for new or small business to borrow money, which might be one aims of the
central bank policies. And, there is always a time lag for expansionary monetary policy to take
place, it’s effect is not instantly visible.
Essentially, even though this policy is really promising, there are also some negative aspects that
the central bank should consider when making expansionary changes to alter inflation.

Word count: 745

Bibliography:
● Aggregate demand and aggregate supply curves. Retrieved from
https://www.khanacademy.org/economics-finance-domain/macroeconomics/aggregate-supply-
demand-topic/macro-equilibrium-in-the-ad-as-model/a/building-a-model-of-aggregate-demand-
and-aggregate-supply-cnx
● Bloomberg - Are you a robot?. (2019). Retrieved from
https://www.bloomberg.com/news/articles/2019-03-12/india-s-inflation-quickens-as-focus-shifts-
to-april-rate-cut
● Q&A: What is inflation?. (2014). Retrieved from https://www.bbc.com/news/business-12196322
● South Asia :: India — The World Factbook - Central Intelligence Agency. Retrieved from
https://www.cia.gov/library/publications/the-world-factbook/geos/in.html
● What are interest rates?. (2019). Retrieved from
https://www.bankofengland.co.uk/knowledgebank/what-are-interest-rates

Criterion A (diagrams): 3
Criterion B (terminology): 2
Criterion C (application): 1 – there are a couple of confusing stuff that I pointed out
Criterion D (analysis): 2 – there are a couple of confusing stuff that I pointed out
Criterion E (Evaluation): 4 – well done