A macro-econometric model of the Indian economy shows that a 10 per cent sustained increase in real public investment in non-agriculture sector, financed by money creation leads to an annual inflation rate of about 2.3 per cent and additional GDP growth of one percent, on an average, during the first two years, while in the span of 10 to 15 years, inflation rate rises to about 17 per cent per annum and additional output growth slows down considerably to average 2.7 per cent during this period.
The literature has focused on the use of monetary policy to smooth output in the relatively shorter run. But the flexibility accorded by a “rules-based, but not rule-bound” approach can be oriented in other directions. For example, it can be used to contain financial imbalances, by applying the same approach as we adopt when facing other sources of inflationary pressure.