work for Indian monetary policy for the future, in contrast to the RBI governor’s recent speeches canvassing for multiple targets, multiple instruments and no accountability for the RBI.
The first point is that of independence. In today’s India, the RBI does not have autonomy for the one issue where autonomy matters: monetary policy. The RBI is able to have its way on many things. As an example, it has unfortunately succeeded in crippling India’s financial system in numerous dimensions. But it ultimately has to comply with the views of the finance minister on monetary policy. This is an uncomfortable state of affairs for India. This brings election considerations into monetary policy, leading to inappropriate monetary policy choices. It gives unfairness in elections: the incumbent government is likely to ensure that, in an election year, monetary policy is accommodating, and an inflation crisis is likely to present itself in the post-election period. A monetary policy that delivers stabilisation of India’s business cycle requires an independent central bank. But at the same time, no government agency can be given power to run amok without checks and balances. While all sound economies have independent central banks, they all have strong accountability mechanisms. Any call for an independent central bank must be accompanied by a credible plan for achieving accountability. This is the only way for politicians to agree to the idea of handing over monetary policy to unelected monetary economists.
This involves three elements. First, the functions of the RBI need to be pared down to the narrow core for which independence is justified — setting the short-term interest rate. Second, the RBI needs to come up to the standards of the best central banks worldwide on transparency. Third, the agency must have a quantitative monitorable target: such as that of achieving 4 per cent inflation in the medium term. Such an “inflation targeting central bank” is the configuration which all the good economies of the world have. It is the direction for India too.