Evolution of central banking in India

An insightful speech by Rakesh Mohan on the topic. He begins looking at evolution of central banking from a global perspective:

Evolution of central banking is essentially a twentieth century phenomenon as there were only about a dozen central banks in the world at the turn of the twentieth century. In contrast, at present, there are nearly 160 central banks. This is not surprising since the need for central banks obviously emerged as banking became more complex, while becoming an increasingly important part of the economy over time. The many vicissitudes experienced by banks and their depositors inevitably led to cries for their regulation. Second, central banks are essentially a nation state phenomenon, and hence proliferated as nation states themselves emerged and multiplied: again a twentieth century phenomenon. Third, it is useful to recall some of the reasons for the origin of central banks: to issue currency; to be a banker and lender to the government: to regulate and supervise the banks and financial entities: and to serve as a lender of- last-resort.

This is ironic since much of the current professional thinking is that a central bank should be independent of government, should no longer be a debt manager of the government, and should not regulate or supervise commercial banks. The new objective function assigned to the central bank is to focus on This is perhaps not surprising since price stability was historically achieved, along with preservation of currency value, through the gold standard, and  later through the dollar anchor and its relation to gold. The world lost its monetary anchor on August 15, 1971 when the US decided to delink the dollar from gold, and has been floundering ever since in search of a new anchor.

After the convulsions of the 1960s and 1970s, mainly related to the financing of the Vietnam war, the expansion of world liquidity, and the ensuing somewhat enduring inflation, along with Latin American fiscal and monetary expansion, the new holy grail is independence of the central bank, a concept that is becoming almost synonymous with inflation targeting. And here, though I am too new to central banking to really offer a definitive view, I have to admit to a certain skepticism related to the current fashion among central bankers.

Two pertinent questions are natural to be asked. First, why is it so obvious that central banks should abandon their ‘parents’, the sovereign government? One quick explanation could be that the central banks have ‘come-of-age’ in recent years. But then, some instances like the case of two currencies in Iraq in the 1990s and that of the Bank of Japan in recent years provide a contrary view to the ‘come-of-age’ hypothesis (King, 2004). Second, is it really the case that supervision and regulation of banks by the central bank leads to conflict of interest? In consideration of this conflict, the Financial Services Authority was established in the UK in 2000, and a number of countries have followed suit. What I would like to do today is to explore some of these issues as they relate to India at the present time.

He then looks at how RBI came into being. The central point he makes is though RBI is a central bank responsible for monetary policy, RBI has played a much wider role in development of Indian economy. This is because of both, Indian economic situation (high poverty, large rural population, high poverty etc) and lack of proper institutional framework which made RBI do bulk of economic development.

Read the whole thing.

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