Monetary Policy Committee: Credibility and consistency

Come August 2, the six-member Monetary Policy Committee (MPC) will announce its verdict. This is the sixth meeting of the committee and much water has flown under the bridge since the MPC came into existence. The good thing is that the fledgling MPC may be just settling down, with the committee members delivering a spilt verdict in June. However, there are still some thorns in the flesh as far as the MPC’s operations are concerned. 

Not many people are aware that the Reserve Bank of India (RBI) had published a research paper in 2007 on the operations of MPC across different countries. There were some remarkable findings regarding the literature survey of MPC operations in major countries. For example, in the surveyed literature it was found by the authors that there was no substantive case to argue committee decisions were better than more autocratic processes. It was also established that even as MPC promotes discussion and information sharing, it may also entail the risk of free riding. In fact, majority voting may even have weakened accountability besides reducing the informational efficiency of decision-making.

Notwithstanding such observations, the paper, however, concluded that the concept of MPC brings to the table diverse perspectives, independent thinking, technical expertise and pooling of analysis. The paper constructed an index of sufficiently empowered MPC on various parameters across countries and concluded that (between 2002 and 2006) more empowered MPCs seem to deliver better inflation results (level and volatility) but with no improvement in growth outcomes. Additionally, to accommodate the possibility of outlier countries impacting the group average (countries such as Brazil and Turkey have relatively more empowered MPCs but also a history of high inflation), the Index of MPC empowerment was also constructed excluding them. 

We went a step further to validate whether the results hold post the financial crisis. Interestingly, the result for the period 2009-15 changes as inflation volatility is surprisingly increasing with more MPC empowerment, but with no visible improvement in growth outcomes. If this is true, it clearly puts a question mark on the efficacy of MPC post the financial crisis. Does this mean the MPC failed to deliver on its exclusive mandate of inflation targeting? We did some research on this and these were the results. 

The success of inflation targeting is sometimes overemphasised. Between 2002 and 2008, inflation declined in most of the countries and this was mainly attributed to increase in information technology-engineered productivity. To validate the above, we analysed the productivity and Consumer Price Index (CPI) inflation data for inflation targeting countries. We found that in half of the 19 countries that we had studied there was structural break in total factor productivity after the adoption of inflation targeting regime. And post that structural break, productivity increased in 12 economies, of which nine exhibited a decline in CPI inflation in the post-break period compared to the pre-break period. Some food for thought for the MPC then? 

Let us now turn to some of the fundamental issues regarding the MPC. One of the common criticisms of the MPC is that if we take a look at the minutes of the Fed meetings these are more spontaneous and there is much more detailed discussion regarding the various aspects of the economy before arriving at the conclusion. But the MPC discussions in the Indian context seem to be more structured and sometimes the consistency in arguments seems to be time-varying. With the progress of time, we hope such discussions will become more nuanced, spontaneous, lively and backed by members’ own forecast and not purely by the professional forecasters’ data as published by the RBI. 

The most compelling observations regarding the various facets of MPC operations is, however, by Alan Blinder (2008). Blinder was the vice-chairman of the Board of Governors from 1994 and served till 1996 and was known for his plainspeak and critical appraisals. One of the most important remarks of Blinder was regarding the composition of the MPC. He was rather forthcoming in saying that contrary to popular perceptions that monetary policymaking should always be made by outstanding technocrats (Ben Bernanke, Stanley Fischer etc), only having outstanding PhD macroeconomists on the MPC was not a pareto optimal solution. Blinder also mentioned that members of the Federal Open Markets Committee and the European Central Bank Governing Council were mostly career central bankers (read market practitioners in the Indian context) that contributed to the MPC success. 

In fact, concentrating on accomplished research economists would have meant Paul Volcker (an outstanding government official) and Alan Greenspan (a business economist) not sitting on the MPC. To quote Blinder: “My own experience on the Federal Reserve Board taught me that it is useful to have colleagues with more experience in banking, and in financial business in general, than academics normally have — even if these colleagues don’t understand linear quadratic models. I don’t necessarily believe that publishing a lot of notable scholarly work on monetary economics is the best possible credential for a central banker.”

Some of these observations may find echo in the Indian context.

The MPC has been entrusted with the onerous job of setting rates in the Indian context and to be fair, we should give it time to get accustomed to the enormous cynicism and glare in the public domain. But it is also expected that the MPC takes into cognisance the ground realities and makes decisions accordingly. The spilt verdict in June hopefully will set the ball rolling for more diverse discussions on a going-forward basis? Will it be 6-0, 5-1 or 4-2 on August 2? My bet is the odds of a rate decision (preferably cut than hold) this time could be 4-2. Let’s wait till then. 

The author is group chief economic advisor, State Bank of India. The views are personal

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