In crisis, play by the book

With the monetary policy committee (MPC) concluding that elevated inflation has constrained it from easing policy rates further, despite growth falling off a cliff, there has been much consternation over the apparent “rigidity” of the “flexible” inflation targeting framework.

During periods of extreme uncertainty, there is always a clamour for throwing out the rulebook; for adopting measures that would have been deemed too radical in normal times. The current crisis is no different. Over the past few months, several such policy prescriptions have been put forth. However, one must advise caution. Some of the proposals, a potent mix of policy adventurism and unorthodoxy, while politically expedient, could risk opening the economy to adverse consequences down the road. Some unconventional measures may well be needed at the current juncture. But discarding the principles of sound public policy, though it sounds appealing, could end up doing more harm than good.

Take the growing demand for reworking the inflation targeting regime. With the monetary policy committee (MPC) concluding that elevated inflation has constrained it from easing policy rates further, despite growth falling off a cliff, there has been much consternation over the apparent “rigidity” of the “flexible” inflation targeting framework.

One way out of this growth-inflation quagmire, as has been proposed by some, is for the government to relax the inflation targeting framework. This would involve greater tolerance for higher levels of inflation — either by adjusting the acceptable range of inflation upwards, or by extending the period over which the MPC has to meet its inflation target. Others have suggested shifting from headline to core-inflation as the nominal anchor of monetary policy or incorporating other indicators such as nominal GDP explicitly into the framework. The more extreme ones talk about doing away with the inflation targeting framework altogether.

The government may well decide to lean in favour of any one of these suggestions. But this would be a mistake. Sure, there is a strong argument for the MPC to look beyond the current spike in inflation and ease rates further. But disagreements with either the rationale or the stance of the committee members must not be construed as disagreements with the framework. Raising the tolerance threshold may sound appealing now, but it will inject a degree of uncertainty and unpredictability in monetary policy. Considering that anchoring expectations around the inflation target takes time, frequent revisions are unlikely to help stabilise household expectations. While explicitly signalling a lack of commitment to maintaining price stability, the implicit message from adjusting the framework will be one of deviating from a rule-based framework.

Shifting to a multiple indicator structure will also be problematic. Such a move harks back to the pre-MPC days when there was far greater uncertainty over monetary policy because there was no clarity over the indicator that was dictating the stance of the RBI governor or which indicator would be given preference, and when. Such proposals go against the rationale for shifting to such a framework in the first place — an inflation targeting regime, with a well-defined anchor, is meant to facilitate greater transparency and accountability from the central bank.

Rather, at the current juncture, there must be a concerted attempt to push for more external voices in the MPC, especially since the outcome of the voting seems to bear the governor’s imprimatur. And if the government feels that its concerns need to be heard by the committee then, surely, there are better ways of going about it. In the UK, a non-voting treasury representative sits with the MPC to discuss policy issues. Bringing in, first, a structural change in the conduct of monetary policy and then slowly dismantling it, both, cannot be touted as reforms depending on when one adjudicates the matter.

Another such unorthodox proposal talks about the central bank effectively financing the Centre’s capital expenditure on a regular basis. This is problematic at many levels.

First, notwithstanding problems in estimating potential output, monetisation, even in the rarest of rare cases, should be the last resort. The perils of falling back on this long-discarded policy, and that too on a regular basis, need to be guarded against. Such an arrangement, however well designed, risks falling along predictable lines, tilting the balance of power in favour of the government. Any government, owing to its short-term political imperatives, is likely to be seduced by the apparent simplicity of this idea, unmindful of its long-term repercussions. And it is more likely to favour channeling every last penny it earns on revenue expenditure, leading to a situation wherein the entire budgeted capital expenditure is financed by the central bank. Doing so will mean flirting with crisis, more so when there are demands for easing the inflation targeting framework. It’s almost as if the lessons of the past, the electoral calculus of profligacy, have been forgotten or are being wilfully ignored.

The risk also runs the other way. Giving a central bank a degree of control over the government’s expenditure priorities is not a prudent approach. Whatever be their policy inclinations and expenditure priorities, elected representatives have to face voters at the hustings. Why should unelected technocrats be in charge of determining the expenditure priorities of the government? Are they answerable to the people? Such proposals blur the lines between fiscal and monetary policy and may lead to what some call the fiscalisation of monetary policy.

Another equally audacious idea that has been proposed is for the cash strapped government to pledge its shares in companies and avail loans against them. This raises questions. Should a sovereign pledge assets to borrow in the local currency? In 1991, India had pledged gold for a foreign currency denominated loan not a local currency loan. So why the collateral? And what happens if the value of the shares pledged falls below that of the loan?

ishan.bakshi@expressindia.com

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