Friday, October 17, 2014

RBI autonomy

What exactly is RBI autonomy in monetary policy? Does it set the policy objective (say, primary focus on inflation), the inflation target as well as the means to achieve the target? Are all these the province of the RBI? Or does the government have a say in these matters?

I would think that the government has the right to decide the primary objective and also the inflation target. When it comes to the means of achieving the objective, the decision is primarily that of the RBI but the government should be involved in decision-making.

That is how RBI governors have viewed matters all these years. They have ensured that the government is duly consulted on monetary policy matters and then taken the final call on interest rates. Over the past year, however, the RBI has sought to change the situation somewhat. The Urjit Patel committee recommended that inflation targeting would be the primary objective and it also set the inflation targets to be met. The interest rate policy to meet the targets has also been decided by the RBI. It does seem that there is over-reach on the part of RBI.

Now, moves are afoot in  government to get the balance right between itself and the RBI. The government wants to set the inflation target. Monetary policy will be decided by a committee dominated by outsiders. This amounts to a dilution of the RBI's autonomy as it takes away the RBI governor's right to be the final authority on interest rates. I guess the government's moves were inevitable given the attempt on the part of the RBI to be the sole decision-maker in monetary policy matters.

More in my article in the Hindu, The limits to autonomy.


NS said...

When BJP came into power, only the rich academic and professional credentials of Raghuram saved his neck. Also, BJP was conscious to tread with caution as any economic failure will be a propaganda for Congress. Slowly, the governors have been removed, IAS have been reshuffled including a new Chief Economic Advisor and now it is the time of shaping up Raghuram. Lets see how it goes.
I believe that there was a mortal who said that the volume of knowledge of incumbent PM can be written at the back of a postage stamp.
If someone remembers, a writer was crying that a movie made on his book made fortunes and he was denied a fair share of the cake. Now, the latest book of the same author has been booked for movie even before it was released.
It is time people realised that IIMA grads cannot be taken so lightly; them being a writer or Federal Reserve head.

Anonymous said...

Given the dilution of power of RBI, wouldnt the Govt. use MPC as a tool in misappropiate manner as shown by time inconsistency
theory and theory of political business cycle

T T Ram Mohan said...

NS and Anonymous,

RBI governors have to be taken seriously, be they IIMA grads or not. But government also has a role to play in monetary policy.

It is open to question whether letting the RBI decide the target inflation rate on its own is good policy. True, government may be influenced by the economic cycle but, remember, governments also want to deliver performance and reputation effects matter to governments, not just to technocrats.


Anonymous said...

By making inflation ("CPI") targeting with time frame, RBI Guv appears to be acting like a CEO who has time bound targets.Similarities end there. As inflation is a moving target, such a target is elusive. While inflation targeting has succeeded in many countries, the crisis of 2008-9 has exposed risk of financial instability Hence now there is a case for targeting for an overall fiscal stability (of which inflation is one of the key variables) given the experience of financial crisis during 2008-9. While fiscal stability and interest rate (monetary policy) are domains of govt and central bank.So a trade off between inflation and growth is a prerogative of a govt especially in a democracy. All stakeholders interests need to be factored in Hence ideally there has to be dialogue between 2 entities It is the govt that decided the acceptable level of inflation and a central bank has an autonomy to choose ways & means to achieve that target level (of interest rate). Above all there has to be a transparency and disclosure by a central bank ensuring accountability.RBI guv cannot and should not act like a CEO (even s/he is also accountable to her/his Board of Directors elected by shareholders/stakeholders) unilaterally with a veto