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.