Expansionary Policies in a Slowing Economy

India is currently implementing simultaneously expansionary fiscal and monetary policies to address a slowing economy

Monetary Policy Stance

• The Reserve Bank of India (RBI) has adopted an expansionary monetary policy:
  • April 2025: Repo rate cut by 25 basis points.
  • June 2025: Additional 50 basis point cut.
  • Current repo rate: 5.5%.

Reason for Expansionary Monetary Policy

• Expansionary monetary policy is encouraged  by:
  • weak demand, 
  • low inflation within the band of 4% +/- 2%;
  • an encouraging forecast of 6.5% GDP growth for 2025-26.

Fiscal Policy Stance

• Expansionary fiscal policy: Income tax cuts announced in February 2025 aimed to boost disposable income and consumption.

Economic Indicators

• Inflation: Fell to 3%, the lowest in six years, due to a good monsoon and harvest.
• Credit growth: Slowed to 9% in May 2025, a three-year low.
• Unemployment: Increased from 5.1% (April) to 5.6% (May 2025).
• Despite policies, aggregate demand remains weak.

The Importance of Monetary & Fiscal  Policy Coordination

• Both policies impact aggregate demand and inflation:
  • Monetary policy: Lower interest rates → more investment → higher demand.
  • Fiscal policy: Tax cuts/spending increases → more consumption → higher demand.
• Coordinated action ensures that neither policy cancels the effect of the other.
• In past crises (e.g., 2008), when monetary policy was ineffective (zero rates), fiscal policy stepped in to stimulate demand.

Conclusion

• For the economy to work smoothly, the RBI (monetary policy) and the Government (fiscal policy) must coordinate their actions.
• If both push in the same direction, it can boost growth — but they must be careful not to cause too much inflation.

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