RBI governors don't need an MPC but a helpful finance minister

This morning I read in this newspaper that a new monetary policy committee is about to be formed. Pami Dua, Chetan Ghate and Ravindra Dholakia are completing their terms at the end of this month and the current committee has breathed its last. 

The story also said that sundry economists, when asked about the committee’s performance, recalled their own school days. 

“Could have done better”, they all said. 

The correspondent didn’t ask them what ‘better’ meant in this context. Also, had I been in this young reporter’s place, I would have asked if India needs such a committee at all. 

I don’t think so, unless of course you want to decorate your central bank. That’s an acceptable explanation. Bells and whistles do no harm. 

(By the way I also think the government doesn’t need a chief economic adviser. That post has been reduced to a purely decorative one and the decoration is not always very becoming).

That aside, next week I will write about the futility of inflation targeting and why it was invented. Here let me focus on something more basic: the problem of decision making by committee. In a word, it’s futile. It doesn’t lead to superior outcomes on interest rate policy  

Y V Reddy, the last balanced RBI governor before Shaktikanta Das, understood this perfectly. After all, it was he who set up the first monetary policy committee. But he called it the Technical Advisory Committee and kept the veto to himself. 

Anyway, economists more thoughtful than the current bunch of data-chasers have given decision-making by committee a lot of thought — since the 18th century, in fact. The first to crystallise all the thinking was Marquis de Condorcet in 1785. 

Everyone understood, he said, that committees are useful for aggregating information, but in order for a committee decision to be invariably right, the size of the committee had to be infinitely large. Otherwise it was a toss of the coin. 

This conclusion was based on the assumption that everyone would convey their information to the others honestly, as also vote honestly. But there’s no reason to believe that this is invariably or, even mostly, the case. It may happen; it may not. 

Indeed, more often than not, it doesn’t because the underlying problem is of strategic or tactical voting. 

This can happen when a member does not vote on the basis of his or her own information but about what he thinks is the information that others have — or when he has been dictated to as can happen if he is an insider to the organisation. 

This kind of second guessing almost always leads to wrong decisions and is known as the problem of efficiency in information aggregation. 

Not all committees that aggregate information properly can do so efficiently. This is perhaps why the economists who were asked said the current MPC could have done better. 

The RBI governor does — and always has —-consult a lot of people. He doesn’t need a formal committee for that. Indeed what they all need is better antenna. And even more importantly, helpful finance ministers. 

To conclude, I would urge everyone to read this paper before deciding one way or another.


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