Hi! I hereby invite you to participate in this online discussion forum on the ” Proposed Composition of the Monetary Policy Committee (MPC) by the FSLRC”.
The issue is the following.
The FSLRC has come up with the recommendation that the MPC should have 7 members: 4 members appointed by the Government and 3 members, including the Governor, from the RBI (which, as you all are aware, are appointed by the Government). Whilst taking a decision on interest rates or any other Monetary Policy issue, the decision will be taken by majority vote. Hence, the current system wherein the RBI Governor takes a stance on his sole discretion will be replaced by a consensus system, where the decision is by majority.
I wrote a satire piece in my column Tweakonomics in the Hindu Business Line on this (Strange Bedfellows: What the RBI and the FTII have in common: ( You can view it at http://www.thehindubusinessline.com/opinion/strange-bedfellows/article7482009.ece), in which the tone was that 4 Government representatives on a 7 member MPC takes away the autonomy of the RBI. And this is what started a discussion between my friend Amol Agrawal, who, by the way, hosts this wonderful blog https://mostlyeconomics.wordpress.com/, and me…
I then thought that it may be a good idea to share our discussions through the blog and invite your comments/ views/ queries/ perspectives on this issue too.
This is what Amol had to say about my article:
FTII guys surely have an issue at hand but not sure what the fuss on RBI is..No one is taking any autonomy away!! This is how most so called modern central banks with an inflation targeting framework function…i don’t recall any MPC where Governor has so called veto power. And then the Governor himself was part of FSLRC which talked about modernising Indian financial laws..His own committee talked about similar ideas in 2008..
MPC members are going to have a position like Deputy Governors and who else but govt to appoint them? Govt appoints all regulators and MPC members are just that. Even in Bank of England Govt makes the appointments of MPC who also go through a grilling in Parliament..
Infact one should be following debate on what happened at Federal Reserve where regional Fed members are not appointed by the govt. There is a huge controversy on such appointments especially those in NY Fed who are said to be close to markets.
It is sad that currently much of noise on Indian monetary policy is not from the central bank’s perspective but hallowed Governor’s position. Nothing could be further from the truth.
This is my reply to Amol:
Hi Amol! Thank you for the comments. Your “humble” post is extremely well-written and you’ve taken some fairly interesting digs at the “elite” economists 😛
Here is a take on the MPC from my side. And it is a bit of a counter-view to what you are saying.
1. It is not the veto issue, but the composition of the MPC that I find to be restrictive. There is no need for the Governor to have veto powers; as you so RIGHTLY say in your article, no other modern Central Bank has given those kind of powers to their bankers. We have to make the process more democratic and take decisions by consensus. I totally agree with you here. Further, as you say, whether we have 5 or 7 members in the MPC is also a non-issue. Agreed, again. How does it matter?
The Urjit Patel Committee, as you know, had suggested 5 members in the Committee, with the Governor, Dy. Governor and Executive Director (in charge of MP) of the RBI being 3 and 2 other appointees from the Government who are NOT office bearers in the Government, so that no conflict of interest becomes possible. There is no question of a veto and the policy decision will be by majority. This, to my mind, is acceptable.
Not because there are 5 people, but because the composition of the committee is biased towards RBI officers who have the actual responsibility of carrying out the monetary policy directives. In the FSLRC recommendations, the recommendation is to have 4 members that will be “non-RBI”, whereas there will only be 3 RBI officers.
2. Now for the most important point. Unlike many other “modern” Central banks, the RBI has never really received a mandate that its priority responsibility is to control inflation. So the RBI has always walked the tight rope challenge of “managing” inflation, while also supporting growth. In many modern Central Banks, the LEGAL mandate is benchmarking inflation and hence, even if the composition of the Committee is biased towards non-Central Bank representatives, the Committee works pretty smoothly because it HAS to deliver on inflation. The Fed is a case in point. In India, we run the risk of not having the legal and cultural backbone to do this.
I know, I know…the inflation targeting has come in, right? Yes, so the RBI CANNOT allow the inflation to go beyond 6% and below 2%. But if the inflation is say, at 4.5%. Now what should be the interest rate policy? Here, the culture of the policy balance does play a big role. And the culture is already biased towards supporting growth. Needless to say, the composition of the MPC becomes very relevant here.
3. The US Fed too has a 7 out of 12 members are suggested by the President and okayed by the Senate. So, the composition of the FOMC is biased towards the Government. These 7 members are experts from fields such as economics, finance, markets, etc. While the Fed’s decisions affect not only the US, but also ROW, its autonomy has NOT been seen to be its strength area. There are plenty of Banking Surveys that actually rank the Fed MUCH lower than banks (erstwhile) such as Germany and Switzerland and now the ECB, when it comes to an autonomy score. While an autonomy score is worked out using many parameters, excessive Government representation on the FOMC works anti-autonomy. And hence, while the US inflation has always been low, most banking surveys point out to the fact that it could have been lower! US Central Bank has never really delivered a rock solid low inflation environment such as Germany or Switzerland and one of the reasons has been lack of autonomy!
4. It has also been observed that across all countries, banks with higher autonomy always deliver lower inflation rates than banks with lower autonomy, read Government intervention in any format.
5. Finally, the RBI officers are anyway appointed by the Government (as they should be) and enjoy the confidence of the Government. They are mandated now to stick to an inflation target, which is a number that is decided in accordance with the views of the Government. To make the process democratic is also correct, but to set up an MPC with a composition with fewer members from the RBI…don’t you think this is unnecessarily restrictive?
BTW, in all my readings, I rather liked this article written for the layman by Arvind Virmani and I thought you may like it too! The interesting bit is that rather than go on about the debate, there are actual suggestions on a via media process. Do take a look at it: http://indianexpress.com/article/opinion/columns/an-ideal-mpc-for-india/
Whew! What a long comment I wrote there! Do let me know your views.
Here goes Amol again:
Thanks for the comments.
I don’t know but I guess all RBI employees are govt employees. What difference does it make if govt nominates MPC officials as well? Somehow there is always this perception that govt makes poor appointments which is not the case with RBI at least. Given the choices facing RBI and Govt, MPC is going to be just another elite club of similar degrees, similar universities people. I don’t see much differences really. Forget difference of opinions.
I mean there is too much noise over RBI matters. And then for all you know nothing really happens. Look at SEBI for instance. There is zero hype and it has done remarkable job in last 25 years, From Harshad Mehta scam of 1992 to today, it has changed the entire equity market game completely. You remove the equity market game from India and India story falls flat too, SEBI hardly gets any credit which I think keeps it going as well.
And guess what, there have been hardly any economists etc driving the game. It has all been incredible team work and no one even knows who runs the show. Why can’t RBI be like this?
You mentioned Bundesbank and SNB in the post. Well one strong reason was that they didn’t really hype things. The hubris didn;t set in barring Bundesbank handling of 1990 reunification and SNB’s 2008 crisis management.
Having said that, I don’t know why we don;t debate a world without central banking? It is a classic central planner running the show and creating havoc with the system. Why can’t banks decide their rates based on their analysis? Just like other firms do in their respective sectors, why can’t banks be allowed to do the same? I mean regulation is fine but why set interest rates? Why should a regulator decide prices?
I have recently started to read free banking ideas and am amazed that this aspect of history has been omitted from all banks (like economic history and history of economic thought has been omitted). We deplore govt but just are made to believe central banks are critical for the system. Whereas, all central banks have come via govt. fiat and are to be questioned just like we do for givt. And for all you know, countries like Canada, Scotland, Australia etc did really well before their central bank came up. Even in India, it is really interesting to note that banking was far more freer than it is today. Banks could come and close as firms do. This is competition for you and 101 of economics.
Seeing the central banks role in recent years and how much their performance depends on luck, I am really sceptical of their roles in economic management. There is nothing more ironical than seeing most econs believing in free markets and don’t want intervention. But somehow believe in their fine tuning powers on being appointed a central banker.
Like Friedman himself said that eh would rather have a computer/machine manage the monetary policy than a person….
And here’s my reply:
Well, Amol..that’s a lot of issues you’ve commented on at a go!
1. I agree with you that Government appointments are not really necessarily bad. The extremely credible appointments to the post of the RBI Governor are themselves pointers to this fact. And hence, I again agree that we’ll in fact get like minded people from like minded schools on the MPC. Having said that, the key question is again philosophical: Are we giving enough autonomy to the Central Bank when we are giving them accountability to adhere to the inflation targets?
2. The second point you’ve mooted is deeper: Why have a Central Bank at all! These arguments are really classic! And while its tempting for a free market supporter like me to say that banks be given freedom to set rates under the “regulation” of a Central Bank, I really think that the Indian market is not yet mature for this. In a way, this is a Rules vs. Discretion debate. I think that discretionary monetary policy is important in a country like India, where there are multiple supply shocks, monsoon vagaries, oil dependencies, high poverty rates and priority sector issues. These create sudden volatilities in the overall business environment and hence, discretionary policy movement does seem to be necessary!
What do you think? If there is an opinion that adds on to the discussion, please do leave a comment! Looking forward!