The first ever monetary policy committee (MPC) of the RBI has completed its last meeting and decided to keep the repo rate unchanged while retaining an accommodative policy stance. Since Shaktikanta Das took over as Governor in December 2018, the MPC has cut the repo rate seven times in a row in order to revive economic growth. This has prompted many to argue that if growth is prioritised over inflation, then do we really need an MPC?

Indeed, in the past few months, the RBI has often bypassed the MPC when it unleashed unconventional policy actions like a standalone reverse repo cut, Operation Twist and targeted long term repo operations. Now that the term of the three external members on the six-member MPC has ended (with one position vacant even from the RBI’s quota of three), it is a good time to ask whether we need an MPC at all. I would argue with a resounding yes.

The answer lies in two parts: First, inflation shall continue to be an important anchor for sustainable growth and job creation in the economy. The Covid crisis notwithstanding, once the pandemic is over and the fiscal-monetary stimuli start showing results, it will once again become important to rein in prices. It is not very long ago that we experienced a five-year spell of inflation above 8 per cent during 2008-13, which partly contributed to a slowdown in economic activity at the time. Since then, the RBI has been successful in anchoring the public’s inflationary expectations. The worry is that if the public comes to believe that the Central bank has abandoned inflation control, contracts will start pricing-in high inflation, resulting in a self-fulfilling prophecy.

Inflation control

That does not mean the RBI should obsess about inflation when the economy is in the ICU. The MPC has rightly been cutting the repo rate in line with the monetary policy mandate to maintain price stability “while keeping in mind the objective of growth”. In fact, that is the whole point of having a ‘flexible inflation target’ in the form of a range instead of a hard target. Perhaps in its initial years, the MPC was too hawkish in trying to target the 4-per cent inflation number, which did not allow for corrective action even when the inflation print kept undershooting the target.

Yet, it is important not to lose control over inflation in the medium term. A commitment to price stability is also useful as a signal to the government that once things return to normal, the RBI will not hesitate to be a party pooper if the government persists with fiscal expansion instead of structural reforms to achieve long-term growth.

The second reason for continuing with an MPC is that the RBI must have a publicly known mandate that keeps its monetary policy actions transparent and independent. Thanks to the MPC minutes, we now have a much better idea of the RBI’s assessment of the economy and the rationale behind its rate decisions than before. The transparency is important to keep the public and the markets prepared for future changes (or what the RBI calls “forward guidance”). Such actions build investor confidence.

Proper autonomy

Just a few days ago, we saw the Turkish lira collapsing as investors pulled out of the country, which was battling persistently high inflation, and the central bank of Turkey is now left with net negative forex reserves. Having a clear objective makes a central bank accountable, and at the same time, gives it functional autonomy from the government. This autonomy is an important ingredient of macroeconomic stability, and relegating the role of the MPC would pose serious risks to the hard-earned success in anchoring inflationary expectations and stability of the exchange rate.

One can justifiably ask if a headline inflation target is appropriate for a developing country that operates below full employment. In that case, the government and the RBI can consider an alternative nominal anchor for the MPC to target. Average inflation (where the target is met over a year or two) or nominal GDP (which is unaffected by supply shocks) are possible candidates. Or, the MPC can be given an explicit dual mandate (of price stability and employment), like the Federal Open Market Committee in the US.

Apart from redefining the target, the government should concentrate on rebuilding a high-quality MPC. The vacant position from the RBI’s quota can be immediately filled by Mridul Saggar, the new head of the Monetary Policy Department. And the three external positions can go to reputed macroeconomists — preferably from academia — to insulate against suspicions of government interference; this had worked very well the last time.

The writer is Professor of Economics at IIM-Kozhikode

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