By Amol Agrawal
In the last month of 2023, the governments of New Zealand and Australia changed the remits of their respective central banks, the Reserve Bank of New Zealand (RBNZ) and the Reserve Bank of Australia (RBA). The changes in RBA and RBNZ only add to the growing number questions over central bank objectives.
Milton Friedman, in a 1968 speech, said there are three major goals of economic policy: high employment, stable prices, and rapid growth. Within economic policy, Friedman noted that monetary policy can only work towards achieving price stability. Ever since, the world of central banking has been divided on whether central banks should have single mandate of price stability or multiple mandates (of, say, price stability along with other goals). Single-mandate central banking was pioneered by the RBNZ in 1989 , followed by the central banks of Canada, Australia, England, and more. The US Federal Reserve remained a dual mandate central bank, with the goals of maximum employment and stable prices.
The 2008 crisis challenged all pre-crisis doctrines, including the ones on central bank mandates. Amidst the mayhem, central banks were under pressure and criticised for their narrow mandate. The discussion called for a broader mandate and including employment and financial stability along with price stability. The Fed’s dual mandate, which was once criticised, suddenly became the gold standard. The central banks’ response to criticism was mixed. As most central banks implicitly focused on financial stability, they made internal changes to make the goal explicit.
So, for instance, Bank of England instituted a Financial Policy Committee for managing financial stability, and the Monetary Policy Committee continued to focus on price stability. The Fed appointed a new vice-chairperson for supervision. The central banks also modified the Inflation Targeting Framework (ITF) as flexible inflation targeting for accommodating growth.
When it comes to including employment or growth, central banks can not do this on their own. Only governments can make the necessary changes. This is what we see in the case of RBNZ and RBA. In the case of RBNZ, we have seen multiple changes in the last five years. In 2018, the then newly-appointed government amended the central bank law to include maximum sustainable employment along with price stability. In 2021, housing prices was added to the remit. In 2023, a new government was elected, which has again restored the remit to the single mandate of price stability. After 30 years of no change, the RBNZ’s mandate has swung like a pendulum from one end to another. In case of the RBA, the government has changed the central bank mandate from a single focus to a dual one by including maximum employment.
As both the RBNZ and the RBA have long been celebrated for their monetary policy frameworks, these changes have implications for global central banking. It is just that we do not know the direction of the change. One central bank has swung too quickly across mandates while the other has just shifted to dual mandate. If the RBA gets success in managing the dual mandate, then it will draw attention and usher changes.
What does the above discussion mean for Indian central banking? For 80 years (from 1935 to 2015), the Reserve Bank of India’s (RBI’s) remit included multiple objectives with no clear hierarchy: regulate bank notes, establish monetary stability, operate the currency and credit system. In 2016, the government modified the remit and the RBI became a flexible inflation targeting (FIT) central bank. The RBI was given an inflation target of 4+/- 2% while also keeping the “objective of growth in mind”.
The new remit prioritised inflation over other objectives. From 2016 till the time of outbreak of pandemic in March 2020, FIT worked well as average inflation was 3.5%. Post-Covid and the Russia-Ukraine war, the record of FIT has been unsatisfactory as average inflation has been around 6%. In terms of growth, the average quarterly growth rates in two periods has been 5.4% and 4.6%, respectively.
Given the RBI’s FIT is just seven years old, it is too early to call for a change. It takes time for a new framework to mature. The period has been marred by major shocks of pandemic and wars, which shook even the mature inflation-targeting central banks. The RBI may have adopted FIT, but, as mentioned above, the central bank has multiple functions. It is the regulator of banks, the banker to government, the manager of currency, government debt & foreign exchange, and also must facilitate financial inclusion. The central bank has to balance these functions well, and any oversight leads could lead to an internal crisis as seen in the case of the recent banking crisis. The central bank was also tested in 2022 when there was pressure on rupee as the Fed tightened policy rates.
The history of central bank mandates suggests it is best to have single mandates. However, the developments in the last few years suggest central banks have to be flexible not just in terms of inflation targets but in their overall approach as well. There is also discussion on whether climate change should be included in the mandate of central banks. The high political and economic uncertainty also means uncertainty over central bank remits.