Rate setting by committee
In June 2008, then Reserve Bank of India (RBI) governor Y.V. Reddy issued a statement from the sidelines of a conference in Pune. What he said then provides some interesting insights into the process of monetary policymaking in India, at a time when such dreary matters have improbably hit the headlines.
The latest inflation data had been a shocker. Prices were rising at the fastest pace in 13 years. Reddy said he had detailed discussions with his colleagues in the central bank, had spoken with then prime minister Manmohan Singh and finance minister P. Chidambaram, and had consulted with members of the technical advisory committee on monetary policy (italics added). It was an advance warning that the central bank was about to act to quell the inflationary fire. A day later, Reddy hiked interest rates by a steep 50 basis points, besides using other policies to tighten liquidity. One basis point is one-hundredth of a percentage point. This forgotten episode is important at a time when there is a heated debate about the coming shift in the way monetary policy will be conducted in India. There is a wide consensus that monetary policy should be decided by an empowered monetary policy committee rather than the central bank governor alone. The ongoing debates are about how this committee is to be appointed: by the government or the RBI?
The reason I have mentioned what Reddy did in the middle of 2008 is to highlight the fact that the RBI governor does not take unilateral decisions as some would like us to believe. A major policy shift in June 2008 was preceded by discussions with the government as well as the technical advisory committee, which is a monetary policy committee without any statutory power. Of course, there have been several times when the governor has taken interest rate decisions at odds with what a majority of members of the technical advisory committee believed should be done. An empowered monetary policy committee where the governor is at best a first among equals is the practice in an increasing number of central banks across the world. The final decision whether to increase, decrease or not change interest rates is often a subjective call, rather than a mechanical one derived from a rule such as Milton Friedman's famous fixed money supply growth rule or the modern Taylor Rule. The move to policy by committee will be a welcome change since a group decision reduces the risk of the analytical biases of one person skewing monetary policy.
But that still leave us with a tricky question: how different would Indian monetary policy have been if it had been decided by a committee in recent years?
The RBI has been publishing the minutes of the meetings of the technical advisory committee since January 2011. A comparison between its recommendations (or rather, what the majority of members said) and what the RBI eventually did in its subsequent policy provides interesting insights into the nature of the coming transition. There are two particular periods I want to focus on: the first when inflation began to accelerate after the rapid economic recovery following the global financial crisis, and the second in the months preceding the run on the rupee in July 2013. Let us consider the inflation crisis first. It is now widely accepted that the RBI was behind the curve. Wholesale price inflation peaked in March 2010 while the policy interest rate peaked only 19 months later in October 2011. The RBI eventually raised interest rates by a total of 200 basis points to bring inflation under control. The technical advisory committee had suggested only three rate hikes of 25 basis points each in that year. The central bank was behind the curve. But the quasimonetary policy committee seems to have been even more so.
Now, let us move to the months before the rupee crisis. The RBI cut interest rates by 125 basis points from March 2012 to March 2013, even as the current account deficit was widening to dangerous levels. The technical advisory committee did not suggest rate hikes to protect the currency in those months either. The central bank began another cycle of monetary tightening after the rupee came under attack in July 2013. The minutes of the technical advisory committee meetings over the past couple of years show the members were generally less hawkish than the RBI. But they have also failed to anticipate the monetary easing that began this January.