The solution may lie in understanding the nature of business cycles in emerging markets such as India. They argue that emerging economies experience frequent policy regime switches, leading to substantial volatility in trend growth. Think about the substantive policy changes that the Indian economy has experienced after Independence, in the form of government spending shocks, bank nationalization, trade policy changes following frequent balance-of-payments crises, liberalization, monetary policy shocks, and the more recent massive shocks of demonetization and the goods and services tax. Therefore, the business fluctuations in developed countries are transitory fluctuations around a stable trend, while fluctuations in emerging markets stem more from shocks to trend growth. If we follow Aguiar and Gopinath’s logic, the first thing that policymakers ought to do is avoid shocking the trend growth through abrupt and substantive policy changes.

Source: Mint February 20, 2020 17:15 UTC