By: Srinivasan K. Rangachary
With the terms of the three external members of the Monetary Policy Committee (MPC) coming to an end, there is talk of giving them a short extension until March 2021, which is the terminal month of the current inflation-targeting regime. The three external members of the six-member panel are IIM Ahmedabad’s Ravindra Dholakia, Delhi School of Economics’ Pami Dua, and Indian Statistical Institute’s Chetan Ghate. The other three are ex-officio members from the Reserve Bank of India (RBI), with the Governor heading the MPC. The MPC needs to be scrapped, not given an extension. This implies that the three external members can be given a tearful farewell for a job badly done over the last four years, when the MPC messed up its estimates of inflation and kept rates too high. The MPC thus contributed to a worsening of the growth climate even while marginally damaging the balance-sheets of banks and borrowers.
While external analysts are inclined to give the MPC some credit for keeping inflation down, the moot point is whether the low inflation in the first term of the Narendra Modi government had anything to do with its own punditry. It was more the result of low commodity prices, especially global oil, the weakening growth impulses in the economy, and the government’s own decision to fix the fiscal deficit by higher fuel taxation, among other things. The MPC had nothing to do with this achievement. The real damage was, incidentally, done by two members from the RBI itself, the previous Governor Urjit Patel, and his Deputy, Viral Acharya. Patel was the one who pushed the idea of inflation-targeting and in most MPC meetings he (apart from Acharya) was the one who talked most about inflation, according to a national daily analysis of the frequency of the usage of the word “inflation” for every 1,000 words spoken by them at MPC meetings. Patel’s score is 46/1,000, and Acharya’s 37/1,000, with one external member. Ravindra Dholakia (26/1,000) being the only interest rate dove. Dholakia was usually in a minority at most MPC meetings, and the inflation hawks carried the day.
India paid the price for this lunacy. But this has not stopped the MPC’s advocates, including Urjit Patel, from claiming that the MPC must be given eternal life. The assumptions that drove the Finance Ministry under the late Arun Jaitley to set up the MPC relate more to global fashions than anything else. It made the government look good in front of the world’s economic and market experts. But, as the above analysis shows, these “independent” external voices did not really carry the day, and hawkish governors did what they wanted. When push comes to shove, it seems, the power of the governor usually sways the vote. This implies that what the MPC actually achieved is the opposite of what was intended: it enabled governors to claim MPC backing for flawed policies, thus shifting responsibility for negative outcomes to a committee rather than themselves. This does not make sense. Power must go with accountability. The MPC allowed accountability to be diffused. The fact is neither the RBI nor the MPC can control inflation through a mere rate-setting mandate and monitoring of inflation-expectations.
The low-inflation regime in the US and Europe had less to do with what an “independent” US Fed or European Central Bank did, and more with the power-shift away from labour and towards capital. Globalisation ensures that even faster growth in the developed world need not raise wage costs, since companies can easily shift production to lower-wage countries. Thus wage-led inflation is almost impossible in the West. What can be concluded is that the developed world’s central bankers have the ability to lower inflation at the cost of growth, but given wage insecurities due to globalisation, they are loath to do this even when warranted.
Thus, they make one-way bets on growth by keeping rates lower than necessary to keep unemployment down in the developing world, where supply-side constraints are more influential in determining the direction of inflation than wage costs, central banks find it easier to push up inflation than lower it. This is because developing countries pay a huge price in terms of growth (and social costs) for lowering inflation. In fact, this should be obvious from our growth-inflation performance during the UPA and NDA times, where the former saw higher growth with higher inflation, and the latter lower growth with lower inflation. The inflation-targeting regime is ill-suited for central banks in all countries, developed or developing, for different reasons. This does not imply that central banks should focus more on growth in developing countries, for that too is not controllable by monetary policy. What he recommends is giving central banks narrower mandates over things they can really control, including credit growth. The monetary response to economic conditions should be focused on variables that indicate “overheating”, at which point the central bank can slow things down by control of credit growth and money supply. And vice-versa.
If we accept this argument, and the MPC’s manifest non-performance, we need to do two things: abandon the inflation mandate in its current form, and instead ask the RBI to monitor indicators that indicate overheating or excess contraction. Secondly, this job of monitoring observable indicators can as easily be done by an in-house RBI economics team rather than an MPC. The RBI’s old, informal technical advisory committee, which did the job the MPC was mandated to do later, worked just as well. INAV