As RBI tries to become a BoE clone, BoE tries to become like RBI…

As RBI evades Government/Parliament to adopt the fancied inflation targeting regime, things are changing in the inflation targeting world.  They still say they are inflation targeters but are looking at all kinds of things. Call it flexible inflation targeting which is nothing but RBI’s now discarded multiple indicator approach.

One such case is Bank of England which is even more interesting as RBI is going to try and become like BoE over the years. The RBI committee report borrows heavily from Bank of England framework.

There has been lot of discussion on forward guidance of these central banks and more in case of BoE. The inflation targeting central banks have all kinds of targets (in the name of flexibility) like BoE has for unemployment. So it had this target that it will keep stimulating till unemployment touched 7%. As it touched 7.1% there were debates over whether BoE will stop its easy policy.

There were two solutions. One to lower the unemp threshold to say 6.5% like Fed did (though US unemp has touched tantalising close to 6.6%) or to revamp its fwd guidance statement. BoE chose the second option.

In its recent inflation report (which is also going to be taken out by RBI), BoE explained its changed stance. And interestingly, BoE will look at many indicators for its future policy just like RBI policy.

BoE head Carney explained:

The first phase of the MPC’s forward guidance was put in place last summer when, following fears of a “triple dip” recession, the UK economy was just emerging from a long period of stagnation, persistent above-target inflation and subdued business and household confidence. Its principal aim was to help secure the nascent recovery by reassuring households and businesses across the UK that the Bank wouldn’t raise interest rates until jobs, income and spending were really growing. Specifically, the MPC set a 7% unemployment rate as a threshold for even beginning to consider whether Bank Rate should be raised. That was a relatively easy call because the considerable slack in the  economy at the time ensured that the
MPC was not taking undue risks with inflation as monetary policy encouraged faster output and employment growth.

As a result of exceptionally strong jobs growth – almost half a million more people have found work since August – the unemployment rate has fallen much faster than anticipated to 7.1%, and is likely to reach the 7% threshold by the spring. The MPC said last August that, once unemployment had reached the threshold, we would assess the state of the economy more broadly, drawing on a wide array of indicators. That assessment is provided in today’s Report.

So what does the new guidance do? You have got to read it to believe it. It is spare capacity targeting!:

First, the MPC is for the first time today providing guidance that it is seeking to absorb all the spare capacity in the economy over the next two to three years. That recognises that spare capacity is both wasteful and increases the risk that inflation will undershoot the target in the medium term.

Second, the MPC is giving guidance that it judges that there remains scope to absorb spare capacity further before raising Bank Rate. Third, the MPC is giving guidance that, if and when the time comes that the economy can sustain higher interest rates, Bank Rate is expected to rise only gradually. For a sustained and balanced recovery, the degree of stimulus will need to remain exceptional for some time.

The timing and pace of any increase in Bank Rate will reflect the degree of spare capacity and the pace with which it is being absorbed. The MPC will be monitoring a broad range of indicators including unemployment, participation in the labour market, average hours worked and the extent of involuntary part-time working, surveys of spare capacity in companies, labour productivity, and wages.

Third, To allow others to monitor how the economy is evolving relative to our projections, today we are publishing for the first time forecasts of 18 more economic indicators. One thing we can guarantee is that the future outturns will differ from these forecasts, but publishing them should help others understand our key judgements and anticipate how monetary policy will respond to the evolution of the economy.

Fourth, the MPC is giving guidance that any increases in Bank Rate should be limited. This recognises that many of the headwinds holding back the economy will remain for some time  yet. Public and private balance sheets continue to be repaired. Weak world demand and the appreciation of sterling will hold back the expansion of net exports. And there remain strains in the financial system despite good progress on post-crisis repair.

Finally, the MPC intends to maintain the stock of asset purchases until the first rise in Bank Rate.

18 economic indicators!! The inflation report has in a way become RBI’s Macro and Mon Pol report released every quarter. The value of latter has been diminished by new RBI top brass by releasing it post mon pol decision. And with RBI now meeting once in two months, this report will perhaps just phase out (if RBI stops publishing it) or fade out (if RBI continues publishing it no one is likely to pay much attention; it could be converted into the inflation report too..).

Deep down, you realise you so called focused central banks have diversified their inflaiton targeting positions to all kinds of stuff much like RBI. This is because economic situation has become really weird and past economic relationships not holding out as well.

Same is the case in India too. Relation between Inflation and growth has weakened as one remains elevated despite growth petering off. And then inflation too depends on whether you look at WPI and CPI. Food price volatility has made inflation really go crazy from a all time high to a drop which no one will believe. This makes any such proposed targeting framework really complex. Moreover, the guys RBI seems to ape have gone into a different direction.

What is more important at this hour for RBI is to stick to basics and not get into this frameworks etc debate. It just wastes a lot of time as people discuss the framework not the policy. They just look reforms for namesake. The debate should be more on economic relationships and policy. RBI should also stop playing flip flop policy holding markets at ransom trying to show its supremacy at each policy.

There is a lot going on in global economy and pre-crisis gold has become near dust. The frameworks can be implemented as the dust settles down. Till then simple policy is all that is needed. Moreover, we also have elections coming up which could pose its own challenges. Who knows the new government might not agree with RBI decisions at all.

The RBI needs to decide whether it wants to be practical or theoretical and not do flip flop between the two..And media/experts should pay attention to what is happening around the globe before calling anything and everything as reform..Everything western is not reform and anything Indian is not an old outdated mindset…


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