The significance of MPC and its first decision are overstated…

On one hand, hunger issues continue to be ignored despite its obvious importance. But on other things related to Indian central bank continue to be written and debated extensively without much importance.

EPW edit says much is written about recent monetary policy decision (sorry resolution).  But the overall gains are overstated and hyped:

The government, which has long sought a rate cut from the RBI but did not obtain one, is certainly pleased. Industrial capital, experts, and sections of the business press have also welcomed the reduction in the repo rate hoping that it will induce private sector investment. However, the risk of high inflation in the near future remains, from possible global increases in fuel prices as well as domestic demand surges following the roll-out of pay increases for government servants. However, the view that monetary policy will by itself affect inflation tendencies, or that it will induce investment in the economy is misplaced. Inflation is caused by many factors largely outside the RBI’s control, and investment is essentially a function of the state of long-term profit expectations, which is not promising at the present. To expect that the cut in the repo rate at this time will magically “restart the investment cycle” is excessively optimistic.

The MPC’s decision has pleased the government but to expect the committee to be a significant forum in which a democratically elected government can intervene in monetary policy is an overestimation of its role and importance. In its current form, the MPC is but an addition to the larger framework where an independent central bank focuses on targeting inflation within a certain range. The MPC is “entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level.” It is to be held accountable for this role, and the minutes of its meetings will be made available to the public. Even as these moves for transparency are important international practices to adopt, the MPC’s mandate for which it is to be held accountable is itself a truncated one.

Inflation targeting is distinct from the multiple-indicator approach that was followed by the RBI earlier, which looked at not only inflation but various quantity and rate variables such as credit, output, and the exchange rate, among others. Inflation targeting has grown out of regulatory frameworks in economies with developed institutions and financial markets, and clear sources of inflation. These economies have sizeable financial markets and services. Earlier, such a single-target approach to monetary policy was not considered very useful in economies like India, where financial markets are far from developed, and inflation sources are vulnerable to food and fuel shocks, making it difficult to identify a “core” stable inflation to target. Two previous governors of the RBI—Y V Reddy and D Subbarao—were not in favour of switching to the inflation targeting approach. Yet this approach has been adopted.

Inflation targeting continues to be considered the “gold standard” of monetary policy in advanced economies. This is even after central banks following such a policy mechanism failed to diffuse asset price bubbles that led to the 2008 global financial crisis. It is largely this mainstream intellectual push in economic policy research that has aided the near universalisation of this rule-based approach to monetary policy in central banks worldwide. The Fiscal Responsibility and Budget Management Act, 2003 that targets low fiscal deficits is already constraining public expenditure on employment generation, food security, healthcare, and education. With inflation control as the primary target of the RBI, further constraints on provisioning of public goods and services are inevitable.

 This is a really old debate.

Should India have these developed world policy frameworks before becoming anywhere closed to developed? Or is it that these frameworks will lead to a developed economy?

History shows that though these ideas of monetary and fiscal rules/targets have been there for a while, countries have been really random at  implementing them. It is only post 1990s that both monetary and fiscal targets became not orthodoxy amidst economists but even policymakers. For most parts of their history, the developed world has spent and stimulated as per its wishes. Likes of Ha Joon Chang nicely call it as kicking the ladder.

There are merits and demerits on both sides. What should be followed is not blind aping of the western ideas. But to look at local contexts and make policies accordingly.


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