An early attack on independence of RBI’s monetary policy committee…(Does it matter?)

If there is one topic on economics where one can continue writing it is central bank independence. It is amazing how the term was barely discussed till mid 1980s, has risen so sharply in economic discussions.

Recently, RBI set up a Monetary Policy Committee which was expected to finally resolve the debate forever. Earlier, the onus was on central bank chief who could be pressurized by the government especially towards cutting rates. But the government can of course not pressurize the whole committee. Thus, RBI monetary policy is independent forever.

Right? Not really.

Mint editorial says attacks have begun on MPC independence:

The new monetary policy framework that India has accepted is premised on a clear division of labour. The government representing the people of the country gives the Reserve Bank of India (RBI) a formal inflation target to pursue. The central bank then gets the operational freedom to meet the inflation target as it thinks best. Is this arrangement already under threat?

The Union finance ministry has summoned the members of the monetary policy committee (MPC) to New Delhi to discuss government views on interest rate policy. The meeting will be attended by chief economic adviser Arvind Subramanian, principal economic adviser Sanjeev Sanyal and economic affairs secretary Shaktikanta Das. There will be two sessions: one with RBI representatives in the MPC and then one with the outside members, a curious arrangement. In an interview to Business Standard last week, Subramanian said that such meetings would be an attempt to “give structure to the government inputs to the MPC”.

The RBI Act does give the government the power to give directions to the central bank in the public interest, after consultation with the governor. The idea is that the government as the sovereign will have leverage over central bank decisions on the occasions when public interest is threatened. It is not a blanket permission to interfere with regular decision making on monetary policy.

Another section of the RBI Act also says the government is empowered to convey its views in writing to the central bank, which again is quite different from regular meetings in the ministry before every MPC decision. We worry that these meetings, as they become regular features in the policy calendar, will eventually become occasions for putting pressure on MPC members. They should not buckle under.

Well, as Dr Reddy nicely put it: Yes RBI is independent but within the boundaries set by the government. It applied to Governor then and applies to MPC now.

We just overdo all this independence talk. We are told each time RBI acts onto some or the other fad, that the independence issue is solved. But again the story of Government attacking independence starts.

No central bank can ever be independent as we understand the word independence . A much better word should have been autonomy but it hardly has the same impact as independence. Autonomy would mean that given the goals set by the Government, the central bank will act to pursue the stated goals.

Earlier also Governors met the Finance Ministry before policy within closed doors but then the Governor took its own actions. Same will be the case for MPC members as well.

On a broader level, the way Government pushed demonetisation breaking all rules from central banking rule-book, all this talk of independence does not really matter. One of the biggest monetary decisions in India’s monetary history was taken without informing MPC members (as we are told), so whether MPC is independent/autonomous or not does not really matter. What several rate cuts and MPC wisdom could not do, was done in a matter of few days as banks cut rates sharply.

So much so, no MPC member even expressed any opinion on them being kept out of the loop and surprisingly had similar sanguine views on economy. One of the reasons for having MPCs is diversity in views. But we hardly see any divergence in MPC views either in India or other central banks. Unless we think of the constitution of MPC differently, we are not going to get diversity.

So all this talk of independence is over stretched. Autonomy is fine and should be respected, but eventually Government has enough ways to pull strings..

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2 Responses to “An early attack on independence of RBI’s monetary policy committee…(Does it matter?)”

  1. Anantha Nageswaran Says:

    A good practical comment. I agree, broadly. But, appearances do matter. There is also an opportunity to have done it in a so-called WIN-WIN manner.

  2. Linkfest - Kairos Capital Says:

    […] Mostly Economics – Does RBI’s independence matter? […]

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