SPEECH EXCERPTS
The following are excerpts from the VKRV Rao Memorial Lecture delivered by Chief Economic Advisor Arvind Subramanian on Thursday
Macroeconomics is central to the work we do at the Ministry of Finance and the Reserve Bank of India (RBI). Many key policy decisions are driven and underpinned by an assessment of the macroeconomic situation. So, whether the fiscal deficit should be higher or lower, whether public investment should be increased or decreased, whether interest rates should be increased or lowered are all questions critically dependent on our assessment of the current state of the economy and where we think it is headed.
Formally, this assessment is made by the key policymakers: The Ministry of Finance broadly on fiscal policy; previously the RBI and now the Monetary Policy Committee (MPC) on interest and exchange rate policies. Of course, sometimes they give advice to each other. (Joke: the advice is almost always unsolicited and always the same: Cut; RBI on fiscal deficits; Ministry of Finance on interest rates; and they of course savour their freedoms to ignore each other.)
In fact, the MoF and RBI are far from the only bodies that give advice. Assessments of the macro situation are — and must be — the result of a far wider process, in which inputs are also provided by experts in the private sector, academia, and civil society. In each case, experts could be Indian or foreign. As an insider, I am an eager consumer of the opinions of outsiders. Indeed, as CEA, I have now read a fair amount of commentary by analysts and journalists. What I see is a clear pattern. And it is a worrisome one. My central thesis is this: Much of this expert opinion, and not infrequently, is liable to being compromised. In short, like Emile Zola criticising those who had unjustly framed a decorated soldier in 19th century France, J’ACCUSE!
What is my criticism? My claim is that experts often hold back their objective assessment. Instead, they censor themselves, and in public fora are insufficiently critical and independent of officialdom — whether the officials are in Mumbai or Delhi. To the extent they offer criticism, it is watered down to the point of being unidentifiable as criticism.
For a variety of reasons, experts feel the need to stay on the right side of power — whether the RBI or government. So, before policy decisions are taken, the experts tend to express the views they think officials are likely to take. After policy actions, they try hard to endorse the decisions already taken. As a result, we in the government do not really benefit from their wisdom. This is a serious problem, because high-quality policymaking demands high quality inputs and high quality debates.
Why is there such little debate about macro policy? I would venture three explanations. First, a major source of macroeconomic commentary is from stakeholders, such as bankers and otherfinancial sector participants, whose relationship to officialdom is not arms-length. Bankers are careful not to get on the wrong side of the government or the RBI, because they worry about losing access and because they are regulated by them.
Second, when it comes to the more disinterested commentators — notably academics — there may be a certain intellectual diffidence. Macroeconomics is profoundly general equilibrium in nature, so the inter-relationships are inherently complicated. Because of these complexities, it is much more difficult to be sure of the optimal policy stance— Keynesian prescriptions are very different from neo-classical ones. All this might well discourage even independent commentators from standing out, from being contrarian to conventional or official wisdom.
That said, I think something deeper is at work. On micro and development issues, India and Indians, are on the global academic frontier. This is less true of macroeconomics. For example, while there are many Indian economists working abroad, there is very little research on Indian macroeconomics even in the US. Part of the explanation is that there isn’t enough high frequency data to make such work interesting. But surely this is only part of the explanation. This is a matter of sociological interest that needs greater investigation.
Today, I want to illustrate some of these ideas with a few examples from recent Indian experience.
Example 1: The International Ratings Agencies
Let me begin by highlighting one of the most egregious examples of compromised analysis: The assessments of the international ratings agencies. In recent years, rating agencies have maintained India’s BBB- rating, notwithstanding clear improvements in our economic fundamentals (such as inflation, growth, and current account performance). At the same time, China’s rating has actually been upgraded to AA-, even though its fundamentals have deteriorated, as these charts from the Economic Survey show.
In other words, the ratings agencies have been inconsistent in their treatment of China and India. Given this record—what we call Poor Standards —my question is: Why do we take these rating analysts seriously at all?
Example 2: Fiscal policy
Let me now turn to domestic examples. On the domestic side, there is a clear relationship between expert analysis and official decisions. Before policy decisions, the expert analysis is often illuminating. But once the decisions are taken, it is truly striking how the tune and tone of the analysis changes. Analysts fall over backwards to rationalise the official decision.
One example is the assessment of the recent Budgets. Before the 201617 and 2017-18 Budgets were announced, outside views spanned the spectrum. Some urged the government to stick to the preannounced target, others to go slow on consolidation; some even asked for expanding the deficit, especially this year, given the weakness of the economy after demonetisation. Yet, whatever their initial view, once the Budget was announced, commentators almost uniformly endorsed the actual government policy. One would have thought that they would at least be mildly embarrassed by their change of views. But they gave no sign of such embarrassment; indeed, they didn’t even admit they had changed their views.
Example 3: Current macroeconomic assessment
Perhaps the epitome of this dynamic can be found in the assessments of monetary policy. Consider how expert assessments have evolved, just over the past few months. After demonetisation, a consensus had built up amongst the investor community and the economic analysts that the RBI would cut interest rates. This consensus was based on (a) a declining trend in inflation from Q2FY17 and (b) the projected short-term adverse impact of demonetisation on growth.
It turned out that the MPC did not cut. Instead in December, it signaled a more hawkish stance (going from accommodative to neutral), and since then has maintained that stance.
Yet, instead of criticising the official decisions, as consistency would demand, analysts found ex-post logic to attribute merit to these decisions. That is, far from criticising the central bank for holding rates constant over the past three announcements, analysts praised the policy stance as prudent and helpful in boosting the credibility of the inflation-targeting framework. While the RBI’s decision may well be commendable, it is odd that before December, experts saw no inconsistency between a rate cut and the credibility of the central bank.
To be fair, some change in position could be warranted either if the official assessment revealed something about the economy that analysts did not previously know or if they learned something new about the RBI’s preferences or reaction function. Since December, there was perhaps one new aspect of preferences that markets did reveal: After some ambiguity in September, the MPC has only subsequently (in February 2017) made clear that its target is 4 per cent not say 5 per cent. Even allowing for this, the analysis and commentary has remarkably toed the official line post facto.
My second point is perhaps even more fundamental. I want now to present a macroeconomic update of the economy. The bott-tom line from this analysis is that inflation pressures are easing considerably; the inflation target has been overachieved; the inflation outlook is benign because of a number of economic developments. Real activity remains weak and well below potential, the exchange rate is appreciating denting exports. Against this background, most reasonable economists would say that the economy needs all the macroeconomic policy support it can get: Instead, both fiscal policy and monetary policy remain tight. And on top of that, there are some officials who even think that policy should get tighter.
Now here are my questions:
Have they (and here I mean the thrust of opinion emerging from the analyst community) highlighted that we have overachieved on inflation well in advance of scheduled targets?
Have they highlighted that core inflation—properly measured—has been declining steadily over the last 7 months and is on target to achieve the medium-term inflation target?
Have they highlighted that an appreciating exchange rate will dampen inflation going forward?
Have they highlighted that ritual invocations that oil prices could increase because of geopolitical risks are less plausible today because oil markets have fundamentally changed, placing ceilings on oil price movements?
Have they highlighted that perhaps z real activity could be recovering slowly, not rapidly, and hence that output gaps could be widening, moderating inflationary pressures?
Have they highlighted that fiscal policy has been tight (and to borrow from Paul Krugman’s phrase perhaps even “irresponsibly responsible”?) and that public investment has not significantly increased at a time of weak private investment?
Have they highlighted that even though liquidity conditions have eased (perhaps alarmingly), the real policy rate is at a recent high and at the previous high, inflation was much greater?
In sum, have they highlighted that inflation is under control and activity may be weakening, calling for all the fiscal and monetary policy support that the economy may badly need?
Let me be clear. The alternative view that I presented — which is at variance with this consensus view both on the assessment and the policy prescription—is not necessarily my view, and may not even be the right view. But it is an eminently plausible view that must be part of the policy discussion; and yet we have not heard it, or even anything close to it. I find this a somewhat disconcerting commentary on the state of macroeconomic commentary in India.
“Truth required diversity of opinion. While that diversity will require both competence and capability, it would also require voices that are not silenced, compromised, or conveniently moderated by the lure or fear of power”
“My claim is that experts often hold back their objective assessment. Instead, they censor themselves, and in public fora are insufficiently critical and independent of officialdom”
"Bankers are careful not to get on the wrong side of the govt or the RBI, because they worry about losing access and because they are regulated by them"
Conclusion
If, what I have argued has some validity, some conclusions follow. We need more disinterested voices—especially universities and independent researchers that are distant from and not dependent upon the apparatus of power— to speak up.
Another conclusion relates to the behaviour of officialdom. All officialdom wants validation for its actions. So, in the short run, it will want to shape opinion in its favour. But in the long run that is perhaps not desirable. Public interest is perhaps better served by richer debate that encompasses critical views, including of officialdom. Officials should signal that clearly. One thing is certain: Truth, no matter how elusive that notion is; the discovery of which, no matter how hard that search is going to be; requires diversity of opinion. That diversity will require both competence and capability. And above all, it will require voices that are not silenced, compromised, or conveniently moderated by the lure or fear of power.