Money control

Last month, the Bank of England convened a two-day conference to mark its 20th year of independence. Notable central bankers were part of that event, insisting on the need to have independent central banks. This is probably one of the mostly widely discussed topics in the monetary policy realm and obtained even more prominence in the post-financial crisis era — when unconventional policies undertaken by central banks raised serious questions about their autonomy.

While delegating policymaking authority to a handful of technical elites stands against democratic principles, there is a compelling case to shield the central bank from political influence to accomplish price stability. And it was proved that an independent central bank with a clearly defined mandate was more capable of keeping inflation lower and stable than others, giving strength to the notion that such an institution is an integral part of any country’s monetary system.

There is a need to give a renewed focus to this topic in India as the central bank here has come under pressure to substantially lower the interest rate despite its inflation projections not allowing for it. If the central bank continues to face such pressure, market participants will start suspecting that monetary policymakers might capitulate at some point in the future.

We must remember that monetary policy can be effective only if there is a strong trust in central banks’ action. If people start questioning it, monetary policy will gradually lose its relevance. So ensuring full-operational autonomy to the RBI is one of the preconditions to achieve, and also sustain, macroeconomic stability in our country.

If the RBI seems to be giving more weight to controlling inflation than growth, this issue should be addressed through Parliamentary process. For instance, the Government should start the discussion with the RBI now to assess whether it is possible to expand the inflation targeting mechanism to include employment mandate. The immediate counterargument would be that employment mandate will not work in a country like India where the parallel economy accounts for a sizeable portion of activity.

But we should remember that the demonetisation exercise, along with the new indirect regime, GST, will likely bring a sizeable portion of informal activity under the ambit of the formal economy, meaning the role of institutional credit (over which the RBI can wield direct control) will gradually expand further.

Also, steps are on to establish employment metrics that are both timely and reliable. When the structure of the economy looks set to change, it is prudent for RBI to alter its framework to account for such changes in order to make its policies more effective and far-sighted.

That said, the concern over letting technocrats have decision-making authority is a legitimate in a democracy. But the best way to deal with this is not by influencing their functioning but by making them more accountable to their actions. The idea of central bank independence can be shown to be reasonable in a democracy, if an adequate accountability mechanism is in place to ensure that the chances of discretionary policy-making are diminished. Thus, apart from looking into the feasibility of including employment mandate in the current target mechanism, more emphasis should be laid on raising the bar on RBI’s accountability.

The writer is an independent economist

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