Why should central banks adjust policy rates by 25 bps and its multiples? Historical evidence from India and England

RBI Governor Shaktikanta Das in a recent speech challenged the status quo:

I do, however, feel that the time has come to think out of the box, including by challenging the conventional wisdom. Let me try and somewhat shock you with one such thought experiment. Typically, modern central banks with interest rates as their main instrument move in baby steps – 25 basis points or multiples thereof – and announce a stance of tightening, neutrality or accommodation to guide the markets and the public on the likely future course of policy. One thought that comes to my mind is that if the unit of 25 basis points is not sacrosanct and just a convention, monetary policy can be well served by calibrating the size of the policy rate to the dynamics of the situation and the size of the change itself can convey the stance of policy.

For instance, if easing of monetary policy is required but the central bank prefers to be cautious in its accommodation, a 10 basis points reduction in the policy rate would perhaps communicate the intent of authorities more clearly than two separate moves – one on the policy rate, wasting 15 basis points of valuable rate action to rounding off, and the other on the stance, which in a sense, binds future policy action to a pre-committed direction. Likewise, in a situation in which the central bank prefers to be accommodative but not overly so, it could announce a cut in the policy rate by 35 basis points if it has judged that the standard 25 basis points is too little, but its multiple, i.e., 50 basis points is too much.

This approach can also be useful when the central bank is on a tightening mode and potentially help avoid policy turnaround from forward guidance via stance too far into the future, which in a highly volatile global scenario, may not even be a year. I am articulating this idea not necessarily in search of a theory but in search of traction with domain experts and more particularly, with practitioner central bankers who face these dilemmas in their day-to-day lives.

This got me interested and one looked a whether central banks tweaked policy rates by other than 25, 50 or 100 bps.

RBI has this table which lists its major policy rates (see similar table in RBI’s online database for data from 1935 onwards).

  • In 1935, RBI had two policy measures: Bank rate and Cash Reserve Ratio.
  • SLR started in 1949.
  • Repo and Reverse Repo rate started in Apr-2001.

In the historical data across different policy measures/rates, we see changes only in 25,50 or 100 bps.

Next, one looked at Bank of England which has published Bank rate since 1694! Bank rate has had many avatars starting as a discounting rate to become today’s repo rate.

Apparently from 1694 to 1980, changes in Bank rate were in 25,50 or 100 bps which was perhaps copied by all other central banks later on. But from 1981 onwards, the central bank makes changes in denominations other than 25,50 or 100 bps:

1981 15.125 0.125
1981 15.0625 -0.0625
1981 14.625 -0.4375
1981 14.5625 -0.0625
1981 14.375 -0.1875
1982 14.3125 -0.0625
1982 14.25 -0.0625
1982 14.125 -0.125
1982 14 -0.125
1982 13.875 -0.125
1982 13.8125 -0.0625
1982 13.625 -0.1875
1982 13.25 -0.375
1982 13.125 -0.125
1982 13 -0.125
1982 13.125 0.125
1982 12.625 -0.5
1982 12.5 -0.125
1982 12.25 -0.25
1982 12.125 -0.125
1982 12.0625 -0.0625
1982 11.9375 -0.125
1982 11.8125 -0.125
1982 11.75 -0.0625
1982 11.625 -0.125
1982 11.5625 -0.0625
1982 11.5 -0.0625
1982 11.375 -0.125
1982 11.25 -0.125
1982 11.125 -0.125
1982 11 -0.125
1982 10.875 -0.125
1982 10.625 -0.25
1982 10.5 -0.125
1982 10.375 -0.125
1982 10.25 -0.125
1982 10.125 -0.125
1982 9.625 -0.5
1982 9.375 -0.25
1982 9.125 -0.25
1982 10 0.875
1983 11 1
1983 10.5625 -0.4375
1983 10.3125 -0.25
1983 10.0625 -0.25
1983 9.8125 -0.25
1983 9.5625 -0.25
1983 9.4375 -0.125
1983 9.5625 0.125
1983 9.0625 -0.5
1984 8.8125 -0.25
1984 8.5625 -0.25
1984 9.0625 0.5
1984 8.875 -0.1875
1984 10 1.125
1984 12 2
1984 11.5 -0.5
1984 11 -0.5
1984 10.75 -0.25
1984 10.5 -0.25
1984 10 -0.5
1984 9.75 -0.25
1984 9.5 -0.25
1985 11.875 2.375
1985 13.875 2
1985 13.375 -0.5
1985 12.875 -0.5
1985 12.375 -0.5
1985 11.875 -0.5
1985 11.375 -0.5
1986 12.375 1
1986 11.375 -1
1986 10.875 -0.5
1986 10.375 -0.5
1986 9.875 -0.5
1986 10.875 1
1987 10.375 -0.5
1987 9.875 -0.5
1987 9.375 -0.5
1987 8.875 -0.5
1987 9.875 1
1987 9.375 -0.5
1987 8.875 -0.5
1987 8.375 -0.5
1988 8.875 0.5
1988 8.375 -0.5
1988 7.875 -0.5
1988 7.375 -0.5
1988 7.875 0.5
1988 8.375 0.5
1988 8.875 0.5
1988 9.875 1
1988 10.375 0.5
1988 10.875 0.5
1988 11.875 1
1988 12.875 1
1989 13.75 0.875
1989 13.8438 0.0938
1989 13.875 0.0312
1989 13.75 -0.125
1989 14.875 1.125

Post 1989, once again changes were in 25,50 or 100 barring in 1996 and 1997 when Bank rate was changed by -0.1875 bps and 0.3125 bps respectively.

It will be interesting to go back in history and figure how 25,50 and 100 bps became the main way to change policy rates. Perhaps the discussion is buried in Bank of England history somewhere from where it spread to rest of the world.  Like my good friend Avinash Tripathi said, this must have been done to keep the uncertainty low. One just had to figure the direction of interest rate changes and it was bound to be in 25,50 or 100 bps. With interest rate changing in all possible denominations, things would have been far more uncertain.

 

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