The central bank, by issuing policy statements all too often, has lost the capacity to surprise the market and manage expectations.
For monetary policy to have the desired impact, a central bank’s communication style could play as important a part as the actual measures taken by it. The essence of effective communication is to manage, rather than be swayed by, expectations.
Financial market participants look forward to sound bytes from top central bank functionaries to be able to figure out what lies in store in terms of policy measures. Their pronouncements could provide clues on the nature of the central bank’s future market intervention, thereby prompting market players to act in a particular manner. Given these possibilities, central bankers are discreet and tight-lipped in their observations. Their public appearances are restricted to select occasions. That, however, is not really the case in India.
TOO MANY SPEECHES
Fed officials made all of 48 speeches in 2011, and have made 33 speeches so far in 2012. In contrast, the top brass of RBI officials delivered 70 speeches in 2011, and already another 70 so far in 2012. The RBI seems to be inspired by the Bank of England where the number of speeches in a year matches that of the RBI. There is, however, a difference.
In the case of the RBI, the burden of communication (read speeches) is largely shared by the ‘big five’ (the Governor and Deputy Governors), and in rare instances by a few Executive Directors. In the case of Bank of England, apart from the Governor and directors, 10 Executive Directors and 10 members each from the monetary policy and financial policy committees share the burden.
One wonders whether the time and resources involved in communicating the central bank’s stance on policy — especially when the number of officials involved is not large — can be put to better use.
Moreover, frequent communication from the top brass can lead to avoidable controversies. The scope for controversy arises not so much from the speeches, as from post-speech media interactions. A case in point is the remark made by Deputy Governor K.C. Chakraborty on the cash reserve ratio for banks. Public appearances during speeches are in addition to the formal media interface during monetary policy announcements. The RBI defends the greater public interface as an attempt to bring transparency in policymaking.
The RBI also indulges the researcher and analyst community through a post-policy teleconference. However, if one were to study the responses given by the Governor and his deputies to the questions posed by analysts in the post-policy teleconference, one finds an element of constructive ambiguity.
Should the top brass avoid their constructive ambiguity? The simple answer is ‘no’.
The economy is a complex machine. One can’t be sure of the exact impact of a monetary action. After all, there is a large informal economy that may not be impacted by monetary policy actions in the same way as the formal sector. Hence, the pass-through of policy actions is weak. In such a situation, it is better to give the system time to absorb the impact of policy measures rather than tinker with the policy on a frequent basis to achieve the desired impact.
Frequent interaction with the media builds up pressure on the RBI to act all the time, without its adequately taking into consideration the lag in the operation of its earlier moves. This could lead to its going too far, as is the case now, when it has hiked interest rates far too often. The practice of holding mid-quarter reviews adds to the pressure.
Rather than pandering to expectations, the central bank’s actions should have the capacity to take the markets by surprise. The RBI increased policy rates 13 times between March 2010 and November 2011 to tame inflation from around 10 per cent to its declared medium term target of 4-5 per cent. The success, however, was limited, as inflation had more to do with supply-led factors, whereas monetary policy measures are more effective in curbing demand pressures.
Inflation at the wholesale level still continues at above 7 per cent and at more than 10 per cent at the retail level. Except for the rate cut on April 17, 2012, on all other occasions, the RBI had delivered what markets had expected. In effect, economic agents had already factored in the rate action.
Theory suggests that anticipated monetary policy is rather ineffective. How could the RBI have expected the rate cuts engineered through baby steps to have any impact, when it was playing into the hands of market players? Low inflationary expectations have yet to materialise. Inflationary expectations still rule at above 10 per cent after so many rate hikes.
The US experience in dampening inflationary expectations in the early 1980s during the Volcker regime suggests that strong monetary action works better than baby steps.
If the RBI were really serious about dampening inflationary expectations, it would have increased rates by 50 to 75 bps, taking the markets by surprise, rather than increasing rates on each occasion by 25 bps. Surprise moves are important for upholding the credibility of the central bank on the inflation front. We have seen that the RBI seems to oscillate between priorities of growth and inflation from time to time. The middle-path approach has not helped in dampening inflationary expectations.
NO MAGIC SOLUTIONS
The RBI think-tank also would be aware of the fact that given the structural rigidities in the system, we would have to come to terms with some inflation till supply constraints are eased. However, it may not like to openly pronounce a change in what it sees as the desirable or tolerable level of inflation.
In a democracy, it would not be prudent to shift the desired level of inflation. In doing so, the acceptable level of inflation would turn out to be a shifting target. In such a situation, it is perhaps better to make policy pronouncements less frequently. Frequent communication has complicated policymaking and led to sub-optimal macro outcomes.
(The author is Associate Dean, Xavier Institute of Management, Bhubaneswar. Views are personal.)