Monetary Policy: Mythili Bisnurmath: ET Blog
Reading Your Lips, Guv
| Also read my online comments at the end |
Let me start by saying I have no quarrel with the
Reserve Bank of India (RBI) governor, Raghuram Rajan’s decision to hike the
repo rate by 25 basis points to 8 per cent last Tuesday. Like most middle class
readers of this paper, who have watched their hard-earned savings get eroded by
negative real interest rates over the past few years, like the governor, I
believe there is no trade-off between growth and inflation in the long run.
Same Difference
So my quarrel is not with the RBI trying to set
inflation on the path for disinflation. My quarrel is with the RBI’s apparent
lack of consistency; with its advancing broadly the same macroeconomic
fundamentals to justify two contrary decisions. Read the latest policy
statement.
Compare it with the 18 December 2013 statement
when the governor chose to keep policy rates unchanged and it is hard to find
any justification for Tuesday’s decision to hike rates. As Rajan himself put
it, ‘Last time round, it was a close call, but we chose to wait. This time,
again, it was a close call; but we chose to act.’ Why?
Prima facie there is no answer. Almost every
reason given by the Bank to justify the hike in the repo rate in January 2014 –
CPI inflation at close to double digits, sticky core inflation, elevated
inflation expectations, wage pressures – was a factor in December 2013 as well.
But even as it accepted that the ‘high level of
CPI inflation excluding food and fuel leaves no room for complacency,’ in December
2013 the Bank found ‘reason to wait before determining the course of monetary
policy.’
There were ‘indications that vegetable prices may
be turning down sharply…In addition, the disinflationary impact of recent
exchange rate stability should play out into prices. Finally, the negative
output gap, including the recent observed slowdown in services growth, as well
as the lagged effects of effective monetary tightening since July, should help
contain inflation.’
The ‘weak state of the economy, the inadvisability
of overly reactive policy action, as well as the long lags with which monetary
policy works,’ meant ‘there is merit in waiting for more data to reduce
uncertainty.’ Then the argument looked weak. Inflation had touched a record
high. But the RBI chose to ignore the weight of months of data showing
entrenched and elevated inflation expectations in the hope that a single data
point one month later would show inflation trending down.
Softer Prices
Most observers, however, were willing to give the
RBI the benefit of doubt. After all, monetary policy is a blunt instrument; the
current bout of inflation in India is largely supply-driven and the economy has
slowed.
And sure enough, when inflation numbers for
December were released, mid-January 2014, skeptics, like this columnist who
believe the Bank should have persevered with its earlier bout of tightening,
were forced to concede that the governor seemed to know his onions. Inflation
was trending down. It was time to call a halt to rate hikes.
No Rules Framework
When vegetable, including onion, prices did
decline sharply and CPI inflation contracted from 11.16 per cent in November
2013 to 9.87 per cent in December 2013, why did the RBI hike rates? Defending
his action, Rajan pointed to how core CPI inflation has remained flat and core
WPI inflation, has risen. But is that reason enough to warrant a hike in the
repo rate?
Not if one were to go by the Rajan’s yardstick
laid out only a month earlier: The bank would act ‘if the expected softening of
food inflation does not materialise and translate into a significant reduction
in headline inflation in the next round of data releases, or if inflation,
excluding food and fuel, does not fall.’ Consider. The first requirement of
this two-part caveat had been met by late January 2014.
Food inflation has softened. There is a
significant reduction in headline inflation. Core inflation, a concept popular
in advanced countries, has no salience in India where food and fuel account for
a major share of the consumption basket.
What is the logic in ignoring what happens to
inflation in a major chunk of the consumption basket and focus on the balance
while framing policy? The answer is, ‘none’, not unless one views the decision
as the outcome of RBI throwing its weight behind the Urjit Patel committee’s
prescription of inflation targeting. There are a number of problems with this.
Not only because the jury is still out on the
benefits of inflation targeting. Or even because the fisc in India is wildly
out of sync with the pre-requisites for such a policy. But because a rule-based
framework allows little scope for discretion, judgment, institutional memory;
indeed any of the reasons the governor relied on to swing the ‘close call’ one
way in December 2013 and the other in January 2014.
Central banking in the brave new world of
tomorrow is much too complex to allow rules to substitute for judgment. Not
when central banks have to keep an eye on no less than three major objectives –
price stability, macro-financial stability and yes, growth.
February 07,2014 at 08:45 AM IST
Though I find myself unprepared
to comment on the text of this article, as a ‘generalist’, I have no hesitation
to endorse the conclusion which reads: “Central banking in the brave new world
of tomorrow is much too complex to allow rules to substitute for judgment. Not
when central banks have to keep an eye on no less than three major objectives –
price stability, macro-financial stability and yes, growth.” Probably, policy
statements(even those made by RBI Governor Dr Rajan or FM Chidambaram) are not
amenable for comparisons of the type attempted in this article. Still,
reminders like this will keep the system alert.
ET Posted on February 7, 2014
Comments