Does inflation targeting represent a vested interest capture by bond markets?

This is a strong piece by Prof Pulapre Balaksrishnan who once worked at Indian central bank. Now he teaches at Ashoka University.

He says inflation targeting has hardly served the common man. It is more in the interest of the bond market which likes such frameworks. RBI has been captured by the same vested interests it has avoided all this while:

John Maynard Keynes was surely right to remark that the world is ruled by ideas and little else. But he may have been optimistic in believing that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil.” Actually, vested interests can ensure that ideas prevail even when they are meant to serve some sectional interests at the cost of others. To those convinced of the infallibility of the principles governing the creation of wealth, it must come as a surprise that some of what is often considered knowledge in the context may be contested on perfectly reasonable grounds or, worse still to their likely horror, merely reflects the interests of certain parties to the transaction, so to speak.

This is certainly true of the reigning view of the role of the central bank. Central banks are pivotal to the economic system and all countries have them. Our own Reserve Bank of India (RBI) is widely admired as arguably the last institution standing up to the machinations of the political class. It has certainly helped that every Indian to have headed it has represented the highest traditions of public service and personal integrity. Persons apart, however, a certain degree of morphing of the RBI has occurred of late, some of it deliberately intended and some of it perhaps in the form of collateral damage.

…..But what about the vested interests that I started out talking about? They are present as follows. Inflation lowers the real value of fixed-income securities referred to as ‘bonds’. Bond holders thus face ‘inflation risk’. As the total value of these securities rises in an economy, a vested interest in keeping inflation low emerges. Wall Street in the U.S. is the archetype here. Its interests are not that of the American worker — that is, it only cares about the real value of the financial wealth it manages. It is also powerful, reflected by the revolving door between Wall Street and the U.S. Treasury, the equivalent of our Ministry of Finance. However, not even this has succeeded in turning the Federal Reserve into an inflation-targeting central bank. Its mandate includes “promoting maximum employment”. The Indian establishment, on the other hand, has shown itself to be amenable to cognitive capture.

Hmm.We also have our revolving door between Delhi, Mumbai and Washington.

How bond markets don’t like the framework initially but learn it is pretty much in their favor. This is a point made by critiques of neo-liberal economic policy too. They say inflation targeting has hardly helped the people. It has driven inequality and all kinds of instabilities in the system.

He says inflation targeting will mean we will just hike rates whatever the source of inflation:

By suggesting via the Finance Bill now that inflation targeting becomes the sole objective of monetary policy in India, the Government of India has not just oversimplified the problem of inflation control, it has also shut out of the reckoning an assault on India’s weak agricultural supply-side. The importance of a strong supply position in combatting inflation can be seen from the history of the U.S. and the U.K. in the last four decades. Following the oil price hikes of the 1970s, these economies went into overdrive in reducing their dependence on imported oil, the price of which could be manipulated by a cartel such as OPEC. This was achieved through a combination of supply and demand-side measures. The U.K. was lucky in striking oil in the North Sea while the U.S. developed an alternative to crude oil from shale. What is less well known is that there has also been a concerted conservation drive, something that we have not seriously attempted as India’s politicians are reluctant to propose any form of belt-tightening.

Not sure about this. There is also evidence of how so called stagflation was an outcome of lose policies followed by Fed. This is an age old argument about India’s inflation. Is it monetary driven or agri driven?

Further, he is worried

Far from being an open-and-shut case then, the adoption of inflation targeting as the sole objective of the RBI is contestable in ways that have been indicated here. It also ignores a serious lesson from the recent global financial crisis, which is that an inflation-targeting central bank can lose control of the financial system. This, after all, was what had happened in the U.S. that had enjoyed a “great moderation” of inflation even as banks were generating toxic assets with the capacity of dragging the system down. It is not sufficiently recognised that at least some part of the present problem of non-performing assets in India is related to poor lending by the nationalised banking sector at a time when inflation was considered to be under control. If a central bank is to have responsibility for financial stability, and this was the original task assigned to it, its focus cannot be exclusively on inflation. In India the Financial Stability and Development Council has taken the task of financial regulation outside the RBI. This is unwise, as the interest rate mechanism can prove to be a double-edged sword. While it may curb inflation when raised, it may at the same time threaten financial stability by tipping indebted entities into insolvency. There is no case for monetary policy and financial regulation to be under the same authority.

This bit will have to be seen. Inflation targeting means central bank does away with the rest. Now IT central banks are saying no no we were always managing financial stability. But as this piece argued, the inflation targeting central banks discovered fin stability post crisis. So how Indian central bank does things will have to be seen.

FSLRC argued for an inflation targeting framework which has been implemented. It also asked to do away with other functions of RBI like debt management, banking regulation etc. How this shapes up will have to be seen.

What we have done so far is pick up bits and pieces of what is liked and gone about it, But inflation targeting is part of a much larger agenda to so called modernise Indian finance. The funny bit is the modern financial systems of west on which much most of FSLRC is based, is itself looking for some ancient roots for survival.

It is all over the place as of now. We should have thought through more carefully on the several issues and look at it from our point of vuew. But with so much of group thinking of similar backgrounds of people, what more can we expect? It is not just central bank that has been captured by vested interests but our entire thinking as well.

It is high time we also give serious thought to the utility of having a central bank at the first place..

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