RBI is Trying to Do Something Impossible

Amidst the on-going severe recession in the Indian economy, the Indian central bank RBI is trying to do something impossible. Driven by its Keynesian logic of lack of aggregate demand as the root cause of the recession, RBI is trying to boost both consumption and investment at the same time. In its recently published bi-annual Financial Stability Report RBI said,

Aggregate demand has slumped in Q2FY20 …

Reviving the twin engines of consumption and investment while being vigilant about spillovers from global financial markets remains a critical challenge going forward.

This is theoretically and practically an impossible task. Let us see why.

Income, Consumption, Saving and Investment

Both consumption and investment come from income and so we need to see the definition of income first. Income refers to the flow of new consumer goods (and services) that an individual has the potential to acquire during a period of time (Murphy 2010).

A portion of this income goes into the use of immediately and directly serviceable goods in the satisfaction of the human actor’s wants (Rothbard 2011). This is consumption; the goods used for consumption are called consumption or consumers’ goods.

Saving occurs when someone consumes less than his income; it is “living below one’s means.” And Investment occurs when ingredients of production are devoted to future income, rather than immediate consumption (Murphy 2010).

I now come to the heart of my argument against what RBI is trying to do. As John Stuart Mill said,

Mill’s second proposition states that “capital . . . is the result of saving” (Mill 1921 , p. 68). In Mill’s words, “To consume less than is produced, is saving; and that is the process by which capital is increased” (1921, p. 70). Saving is discussed in real terms. The source of resources with which to invest are made available only because some resources have been saved; that is, not used as current consumption (emphasize mine).

This simply means that, when we use our income (real resources) in current consumption, we cannot simultaneously use that income in saving, investment and capital accumulation with which to increase our future income. More consumption means less saving and less investment. And more investment means more saving and less consumption.   

So what you consume you cannot save and invest. And what you want to save and invest, you cannot consume. Both these human actions are mutually exclusive i.e., if you do one, you cannot do the other. If the RBI wants to boost consumption then it can’t boost investment simultaneously and vice versa.

This faulty policy prescription is a result of RBI’s faulty theoretical foundation of Keynesian macroeconomics which tells that RBI can just print money out of thin air and boost growth by boosting both consumption and investment at the same time. As we have discussed above, this is praxeologically an impossible task.

RBI is also flat wrong in saying that consumption and investment are twin engines of the economy. As I have discussed elsewhere, consumption is not an engine of any economy. Investment is. Consumption only means poverty in future. Investment means our future income grows with time. And without prior production, consumption is simply impossible. We can only consume more in future when our income rises in future, and that requires saving and investment and curtailment of our present consumption.

Conclusion   

Instead of putting their houses in order, RBI governor Das and finance minister Nirmala Sitharaman keep on telling the businesses to do this and that to boost the growth as if businesses are responsible for the on-going severe recession. Nothing can be further from the truth. Businesses are just reacting to ever changing muddleheaded policies of RBI and Modi government. They are very unsure about the future of this country and so wary of investing anything here. As I have previously said, the Modi government is creating huge regime uncertainty in India via their unending disastrous policies like demonetization, GST and its ever changing tax rates and slabs, tax terrorism,  CAA, NRC etc. India is politically, socially and economically a powder keg right now which can explode at any time. In such highly uncertain time no one is going to invest anything much. Consumers are worried about their future income too when businesses after businesses are faltering and failing one after another unemploying millions. When people are not sure about their future, they start to hoard cash to safe guard their future and tackle any unforeseen contingencies. RBI and government must understand that they themselves are responsible for all the mess in India right now, and they must correct their course by rolling back all their regulations and controls freeing the economy of all burdens of the behemoth Indian government so it can start to grow naturally. The more they will try to boost consumption and investment, the more mess they will create.

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