Central bank autonomy

This is now an old debate. But it's worth getting the perspective of Y V Reddy on the subject in India Forum. 

Reddy begins by noting that the RBI is a full service bank. It appears that bank regulation was added to RBI's mandate down the road along with various functions:

The important functions of the RBI include issue of currency, monetary management, banker to banks and the government, management of public debt, and management of foreign exchange reserves. Over a period, it has subsumed and assumed powers to regulate money, securities and foreign exchange markets, regulation of banks and non-banks and payment and settlement systems. In serving the public good, the RBI has traversed a long distance and faced many challenges. In the process, it has evolved into a full-service institution encompassing regulatory and developmental roles in the financial system, besides partnering with union and state Governments as their fiscal advisor in domestic and external sector policies.

Reddy gives the arguments for and against central bank autonomy. For autonomy:

The first is what is called time inconsistency. Essentially, it means that the time horizon of democratically elected government is short-term and hence they may favour growth over price stability. However, on matters relating to money, actions have to be taken keeping a long-term view. The central bank is expected to take a longer-term view......There is a second reason: that there are political cycles and there are business cycles, which do not coincide. For instance, elections will encourage politicians to have expansionary policies at that time... The third reason is that governments have a tendency to spend more money than appropriate and some limits have to be put on the spending. These can be put in the Constitution. This can also be enforced by independent central banks.

Against autonomy:

There is no democratic legitimacy for a technocratic body to decide on the important matter of money...Second, the independence of central bank may result in friction between fiscal and monetary authorities. Third, a central bank may 'impose' its outlook and preferences on the people, contrary to democratic preferences.

The tricky question is how to enforce accountability. Reddy gives some suggestions:

They should provide regular reports on their policy decisions and the economic outlook and be subject to external audits. Transparency helps build credibility and public trust in the central bank's actions. 

I have advocated external audits for all autonomous government institutions, including RBI. But hardly any of it happening.  It happens rarely and when it does happen, it is perfunctory.

Moreover, central bank autonomy can be largely in respect of the conduct of monetary policy. On various other matters that the RBI handles, such as bank regulation, foreign exchange and management of public debt, there has to be close consultation with the government. Autonomy cannot be sought across the entire range of a full-scope central bank's activities because ultimately the government is accountable for outcomes in a way in which the central bank is not.

  

NATO will give Ukraine arms but no membership

The NATO meeting at Vilnius in Lithuania failed to produce the outcome that Ukrainian President Zelensky was looking for. Zelensky is desperate for NATO membership because that would automatically confer on Ukraine the defence cover that NATO nations are entitled to.

The US and others are in no mood to oblige. They refused also to commit to a time-frame for Ukraine to get NATO membership. There was only a vague promise to consider NATO membership once Ukraine had met “conditions” that were left delightfully unspecified. What NATO Secretary General Jens Stoltenberg spelt out would be of no comfort to Ukraine:

We will provide support to Ukraine for as long as it takes. Because unless Ukraine wins this war, there's no membership issue to be discussed at all.

NATO clearly does not want to be drawn into a direct conflict with Russia because it knows very well that that could lead on to a nuclear exchange. What NATO is happy to do is to continue to arm Ukraine as much as it can. Ukrainians will perish in large numbers in a war that Ukraine cannot win. But Ukrainian lives will help bleed Russia militarily and economically. There is a fond hope in Western capitals that a prolonged war may create enough discontent in Russia to dislodge President Putin. That hope has been belied in the past eighteen months.

It looks as though the stalemate in the conflict will continue. The Ukrainian forces will hurl themselves at Russia in a counter-offensive that produced little thus far. The Ukrainian army has not been able to cross the buffer zone and reach the Russian defense lines. Fresh supplies of arms are unlikely to materially change the situation. More Ukrainian and Russian lives will be lost while NATO cheers from the sidelines.

The problem is that matters may not end there. There is always the risk of a serious provocation from the Ukrainian side. That will draw a severe response from Russia. We cannot be sure that the escalation will not then draw NATO into direct conflict with Russia – with perilous consequences for the world at large.  

C Rangarajan and India's economic reforms

 C Rangarajan was one of the principal figures in the making of India’s economic policies from the 1980s onwards. His memoir, Forks in the Road, should be compulsory reading for those who want a deeper understanding of the reform process.

It will interest IIMA students and alumni to know that Dr Rangarajan was a professor at the Institute for more than a decade and a half. He was at New York University School of Business (now Stern School) when Ravi Matthai, the then director, offered him a job at IIMA.

Dr Rangarajan’s course in Macroeconomics was hugely popular with students. He was entrusted with the task of launching IIMA’s doctoral program. In 1981, he was appointed Deputy Governor of RBI. Thereafter, there was no looking back.

Dr Rangarajan went on to don several hats: Member, Planning Commission; RBI Governor; Chairman, 12^th Finance Commission; Chairman, PM’s Economic Advisory Council. He was also Governor of two states and member, Rajya Sabha. A life of rich accomplishment!

My review article on the book in BS today.

It's behind a pay well, so here is the full text:

FINGER ON THE PULSE

 The ideas of economists

 Former RBI governor C Rangarajan’s memoir is a testament to the crucial role economists can play in shaping policies and people’s lives

T T Ram Mohan

Do economists matter? Can they make a big difference to public policy? Economists will find answers that are gratifying in Forks in the Road, the memoir of C Rangarajan ( ‘Ranga’ to old-timers at IIM Ahmedabad, with which he had a long association in its formative years). Yes, they do. And, yes, they can make a big difference to public policy, provided they can get political masters to align with their thinking. 

Dr Rangarajan’s memoir is about the economic events and decisions in which he was an active participant for nearly three decades, starting in the early 1980s. He wore several hats: Deputy governor and governor of the Reserve Bank of India (RBI); member of the Planning Commission; chairman of the Twelfth Finance Commission; and chairman of the Prime Minister’s Economic Advisory Council (with Cabinet rank). Somewhere in between were stints as governor of two states and member of the Rajya Sabha.

Unlike most memoirs, Dr Rangarajan’s is less about himself and more about issues. It is replete with tables and statistics. But it doesn’t just tell us what transpired. It examines the alternatives that were open to policymakers and explains why a particular course was chosen and what outcomes followed. The result is a fascinating piece of economic history. 

Dr Rangarajan joined the RBI in 1981. As deputy governor and governor (with a break in between), he dealt with two of India’s biggest balance of payments (BoP) crises,  the overhaul of monetary policy and banking reform. 

The first BoP crisis, in 1981, was handled largely within the then economic paradigm. Yet, operating  within the paradigm, Dr Rangarajan and his colleagues at the RBI managed a steady depreciation of the rupee in both nominal and real terms. They were very clear that it would be difficult to manage the current account deficit without boosting exports and curtailing imports.  The economists at RBI seem to have had a free hand in managing the exchange rate even before the reforms of 1991. 

Another significant reform in the 1980s arose from the Sukhamoy Chakravarty report of 1985. Following the report, monetary targeting or setting a money supply target consistent with output growth and prices came into vogue. This was the first attempt to tackle “fiscal dominance” over monetary policy. Here again, the political authority went along with the recommendations of the economists. 

The BoP crisis of 1991 required far more drastic measures. An immediate step was the raising of a foreign currency loan by pledging some of our gold reserves. The Chandra Shekhar government gave the go-ahead, and the Narasimha government that followed raised no objection. Again, a steep depreciation in the exchange rate of the rupee was required. This was done in two stages with the approval of the government. Yet another win for economists.

The achievement of the time, as is well known, was the radical break with the past that finance minister Manmohan Singh pushed through. Dr Rangarajan highlights the three significant breaks that are now part of economic lore: The dismantling of licenses, the reduction in public ownership of business enterprises, and the move away from the inward-looking trade policy of the past. All of this was possible only because of the backing of the political authority. Dr Rangarajan notes wryly that Narasimha Rao was able to rally his party behind him by talking of “continuation” in economic policy when there was really a break. At the time, Dr Rangarajan was at the Planning Commission.

Returning to the RBI in the early 1990s, Dr Rangarajan set in motion reforms in monetary policy and banking at a breath-taking pace. The phasing out of ad hoc Treasury bills; market-determined rates for government borrowing; the dismantling of the administered structure of interest rates in banking; the reduction in  the Statutory liquidity ratio and cash reserve ratio; licensing of new private banks; and a great deal more was done. The chapter is titled “The beginnings of autonomy” but  but the freedom given to the professional economists at RBI was not inconsiderable.

In the management of the external sector, the RBI worked closely with the finance ministry. Far-reaching reforms happened: Foreign institutional investors were allowed into the Indian stock market; foreign direct investment (FDI) norms were liberalised; and the exchange rate became largely market-determined. The framework for management of external capital flows was put in place. There was clarity that long-term equity flows should be preferred to short-term debt flows. These and other measures taken at the time have since become pillars of Indian economic policy. 

On all these, the political authority had no difficulty in heeding solid professional advice. There must have been occasions when the economists couldn’t quite have their way. Perhaps those occasions were not so consequential. At any rate, there is little indication in the memoir of any serious confrontation between economists and the government. On the major issues of policy, once the politicians had decided on a fundamental change of course, they didn’t interfere with the work of economists. On lesser, more technical matters, they always left it to the professionals to do what was required.

The big area of failure for economists has been the fiscal deficit or the savings-investment balance. Dr Rangarajan highlights the point in his concluding chapter, “Ruminations”, where he ponders the long-term outlook for the economy. Over the past three decades, it is an issue that has not proved amenable to the persuasions of economists, no matter what the complexion of government. We have since arrived at times when the global consensus on keeping public debt relatively low has been undermined. Economists themselves seem resigned to greater levels of public debt than they have been comfortable with in the past.

Not pushing through “big-bang” reforms— such as aggressive privatisation, including bank privatisation, land acquisition, and the freedom to hire and fire labour — is seen as a big political failure. Dr Rangarajan doesn’t seem to think so.  He makes little mention of these. “The reform regime,” he writes, “will be incremental in character. It has to be”. That is also the political consensus on reforms.  

Working quietly within the system, Dr Rangarajan was able to make a difference. His place as one of the principal architects of economic policy from the 1980s onwards is secure. For his compelling chronicle of the economic history of the period as much for his many contributions, he deserves a bouquet of the choicest roses.