In these uncertain times, a forward guidance even through scenario analysis would help in anchoring expectations on interest rates, inflation expectations, banking developments and financial markets
The stock markets have recorded significant rally in a single day after the remarks by Governor D Subbarao on the new inflation data released on May 14, barely 11 days after the annual policy announcement. The Governor has purported to have said, according to reports, that he would take into account the softening of inflation in the next mid-quarter policy statement on June 17, 2013. The communication policy of RBI seems to be certainly working in India.
In central banking literature, importance of communication as an instrument of monetary policy has evolved over the years. Earlier, Karl Bruner (1981) sarcastically observed that central banking thrives on pervasive impression that it is an esoteric art, confined to the initiated elite, which cannot be articulated explicitly. Allen Blinder (1996) expressed a view that greater openness might actually improve the efficiency of monetary policy. And Woodford (2001) opined that successful monetary policy is not so much a matter of effective control of overnight interest rates as of affecting the evolution of market expectations. This view has become increasingly widespread amongst central banks over the past decade as issues of independence and public accountability gained importance. The other factor was a recognition that good communication helps to promote confidence in the policy regime.
The objectives of monetary policy can be defined as maximising the economic well-being of the households in the economy. This implies minimising the deviations of (a) inflation from its optimal rate and (b) real economic activity from its natural rate. A successful monetary policy helps to establish a nominal anchor and, in this context, communication plays an important role as it helps to form and manage expectations?an important task for modern central banks. These expectations are fundamentally related to interest rates, exchange rates and inflation. The communication policy is expected to cover four broad classes of issues?interpretations of the economic conditions, content of policy decisions, strategy, and outlook for the future. The debate is whether the central banks? communication about forward guidance could be interpreted as some type of commitment as emphasised by Charles Goodhart (2005) or not, as evidenced by New Zealand, Norges Bank and Sveriges Riksbank, and recent research corroborating that market understands conditionality of projections.
In India, in the context of global market integration and increasing demand from media, there has been a significant progress in removing the mystique surrounding monetary policy as reasoned by YV Reddy (2008). RBI ensures a high degree of transparency about its objectives, policy formulation, and decision making as it helps to increase the effectiveness of monetary policy by promoting more informed decision making by economic agents. RBI?s communication policy involves regular publications, monetary policy documents, research studies and special speeches. In all cases, RBI?s communication has been improving over the years, especially in terms of number of speeches delivered by the top management across the world, mainly in India. The number of speeches by the top management has increased from 30 during May 2008 to April 2009 in 13 different cities to 106 over a similar 12-month period in 2012-13 in 25 different cities. The speeches covered a wide range of issues like inflation, financial inclusion, banking, financial markets, technology in banking, balance of payments, interest rates, debt markets, and inclusive growth. In view of this regular communication, the markets factor in the changes in advance and major macroeconomic indicators do not record any perceptible change on days of policy announcements or reviews. Illustratively, on May 3, 2013, day of last monetary policy announcement, NSE?s Nifty closed lower by 0.92% when compared with the previous day closing. In contrast, NSE?s Nifty rose by 2.52% on May 15, 2013, on Governor?s remarks. This reflects that the communication policy has been effective albeit at the cost of reduced significance of monetary policy.
RBI could consider extending its outreach by ensuring that the speeches by the top management are translated in select national languages and available to vernacular press. In view of rising importance of India and global financial market integration, RBI should also consider translation of select speeches in international languages on its website. In absence of a publication like Beige book, regional developments could be covered more extensively in RBI?s communications and policy statements. RBI has been matching international standards in communications over the years and may consider rationalisation of Part B of the policy document, which reads like a progress report sans policy content. The markets would also benefit from regular communication about policy on external sector. Finally, in these uncertain times, a forward guidance even through scenario analysis would help in anchoring expectations on interest rates, inflation expectations, banking developments and financial markets.
The author is RBI chair professor, IIM Bangalore.
Views are personal