JOIN USThe Reserve Bank of India recently constituted an expert committee to examine the current monetary policy framework and to recommend measures to revive and strengthen it, making it transparent and predictable.
The terms of reference include recommending a nominal anchor for monetary policy. In fact, earlier Raghuram Rajan in his famous report, A 100 Small Steps had observed that a more predictable and transparent policy framework can generate more room for policy makers to respond to large shocks. Still earlier, in September 2000, the RBI Advisory Committee on transparency in monetary policy, and had also recommended assigning a single objective to the RBI, giving it unfettered instrument freedom and holding it accountable for attaining assigned objective.
So, finally, inflation targeting (IT) is on the horizon in India. IT is considered an effective way of anchoring inflation expectations. IT combines rules and discretion, assures transparency, makes the central bank accountable and committed to the public announcement of a target. However, IT also demands operational autonomy.
IT became particularly fashionable after the 1997 crisis but after the recent financial crisis, a number of countries have been in a dilemma to extend the mandate of the central bank to include growth, unemployment and financial stability. Empirical evidence has been mixed on success of IT in moderating inflation. According to Prof. Jeffrey Frankel, Harvard economist, some central banks have feared that given the crisis period they cannot deliver reliably on a quantitative target. Prof. Olivier Blanchard, Chief Economist, IMF had observed that the inflation target band should be raised.
Then, there are countries like Finland, Spain and Slovak Republic, which had adopted IT but later stopped using it. In many countries, there is a question of how to reconcile the objectives of monetary policy with promotion and stability of the financial system. The crisis has led many countries to pay greater attention to the interaction between the real economy and the financial economy. The models which are generally used by the central banks for forecasting inflation, an important ingredient of IT, lack variables which capture interaction between financial sector and house hold sector.
There is a fine distinction between transparency and bare-all-nudity which the policy maker should always consider. Moral hazard, and market discipline could be important considerations justifying limiting the disclosures. Many central banks especially in the west like the US Fed, exuberantly, in their quest for forward guidance and clear communication had committed the policy path which might not have been conducive for growth. It may not be necessary to always spring a surprise on the market but the markets would benefit if the freedom of policy action is retained by the supreme supervisor, the central bank.
India ranks very low on the Transparency and Independence Index (Figure 1 and 2) updated by Dincer and Eichengreen (DE, 2013). In fact, India’s performance was worse than China and much lower than Brazil, Indonesia, South Africa and Sri Lanka. The transparency index prepared by DE takes into account various factors like instrument independence; dissemination of information used in arriving at policy decisions; sharing with public policy deliberations within a specified time frame; explanation of the policy decisions and forward guidance ; and implementation of policy actions.
There has been an extensive debate in the past on applicability of IT in India. Given the advances made by institutions in the economy in recent years, this is a good juncture to revisit the debate on IT. However, it must be recognized that India was probably saved from the global crisis precisely because of its multiple indicator approach, and RBI persisting with policy objectives like price stability, financial stability, and growth while rest of the world was fascinated by great moderation and IT.
In India, the data dissemination by the RBI is extensive and timely. The six-weekly cycle of dissemination of monetary policy review by the RBI is very useful for analysts and academicians. However, the RBI could consider dissemination of regional information like the Beige Book, as is a common practice in the US.
The RBI could also consider dissemination of information on non-performing assets, restructuring of loans and write offs, on a granular basis, regularly. Another area which is blurred is exchange rate management and regular flow of information on RBI’s exchange rate intervention and strategy would help anchor exchange rate expectations. Finally, sharing of information on real interest rates that are considered by the RBI for policy formulation would help markets.
The market also suffers from crowding out due to large government borrowing. Therefore, RBI’s assessment of liquidity in the market could also be shared with the public. Finally, separation of debt and monetary management would provide required operational freedom as well as transparency to monetary policy.
The setting up of the committee is highly commendable and already indicates the transparent approach of the new governor. Hopefully, the committee will help usher in a new era of monetary policy making in the country and the government, operational freedom.
(The author is RBI Chair at IIMB. Views expressed herein are personal.)