In my preceding article (goo.gl/EMTQEo), I had presented data on Indian inflation over the past year, and concluded that neither on growth, nor on inflation, has RBI conformed to any known “models” of central bank behaviour. I had also argued that there was reasonable evidence to conclude that RBI/MPC had not been very transparent, or consistent, in its guidance and that, by allowing the real repo rate (nominal repo rate minus y-o-y CPI inflation) to triple over the last year, to more than 3%, its policies had hurt both growth and employment. There is no question in my mind, or in the minds of most experts, that the MPC should be completely independent in the formulation of monetary policy. Some have suggested that if some government officials believe that the real repo rate should be lowered, then all PM Narendra Modi needs to do is call up RBI Governor Urjit Patel and tell him that he wants the rate lowered. Rarely have I heard worse nonsense than this. Most countries of the world, including India, want their central bank to be independent, warts and all.
But the problem we are facing in India is rather sui generis—the central bank is going against all known models of central bank policy—and therefore the question arises, in the immortal words of Lenin, “What is to be done?”. My simple proposal, which should both preserve independence of the central bank and make it more accountable, is as follows: Change the RBI Act, if need be, to require the RBI Governor (as lead representative of the MPC), to testify to Parliament twice a year. In separate testimony in both houses of Parliament, the lawmakers can ask questions of the RBI Governor and the latter can respond.
Though I have repeatedly asked for clarification of the RBI memo on fiscal deficits (see Farm Loan Waivers, Fiscal Deficit and Inflation, RBI Mint Street Memo No. 05, and my response, goo.gl/cMpjdu), RBI has chosen not to respond. Just to reiterate, in my note, I have stated that important results pertaining to RBI policy on fiscal deficits causing inflation cannot be reproduced. Worse, RBI may have “cherry-picked” the data to suit its (ideological?) conclusion that government policy on loan waivers will have a large impact on the consolidated state-plus-Centre fiscal deficit. This expansion of fiscal deficit of 1% of GDP due to loan waivers (RBI estimate) will, RBI concludes, lead to a large 0.5% increase in CPI inflation. Note that at present we (including self) are in the wilderness about (i) the actual magnitude of loan waivers this fiscal year; and (ii) more importantly, the impact it would have on CPI inflation, the principal concern of MPC policy.
What is the empirical evidence that expansion of fiscal deficits does lead to an increase in CPI inflation?
RBI did not use, in its estimation with quarterly data, the information contained in the data for the years 1996 to 2005 (1996 is the starting year for quarterly GDP data series). The table shows three-year averages of the two variables of concern—fiscal deficit and CPI inflation. Looking at the period 1996 to 2004 (the data omitted by RBI, and omitting the onion outlier year of inflation in 1998), annual inflation declined from around 6.6 % to 4 %. The fiscal deficit expanded from 8 % to 9.4 % of GDP. If RBI had included the data from 1996 to 2005, as I show in my note, they would have found that there is no relationship between fiscal deficits and inflation for the long time-period 1996 to 2016.
Now, let us look at the data considered by RBI on fiscal deficits and inflation, 2006 to 2016. During this time, there is a sharp increase in inflation—from around 6.5% to 9.9% (year ending 2013)—and then a sharp decline, to 4.5% in 2016. The trajectory of the absolute value of the fiscal deficit in the same period follows that of inflation—from 5.7% to 8.3 %, and then a sharp decline to 6.6% in 2016.You don’t need a complicated estimation procedure as RBI has done in its note (just like you don’t need the weatherman to know which way the wind blows)1to conclude that the period 2006-2016 will likely yield to a significant statistical relationship between increases (decreases) in the absolute fiscal deficit and increases (decreases) in CPI inflation.
Ignoring the 1996-2006 data is the clearest, and obvious, form of cherry-picking the data, an intellectual “crime” that RBI seems to have willingly committed. (Such kind of action will be rendered impossible if India were to introduce the policy of jawabdehi). In English, jawabdehi means accountability. The idea behind it is not new. Indeed, it is as old as 1978, when the Humphrey-Hawkins Act was introduced in the US. The Act of October 1978 states: “To assert the responsibility of the Federal Government to use all practicable programs and policies to promote full employment, production, and real income, balanced growth, adequate productivity growth, proper attention to national priorities, and reasonable price stability…to improve the coordination of economic policymaking within the Federal Government.
Attainment of these objectives should be facilitated by setting explicit short-term and medium-term economic goals, and by improved coordination among the President, the Congress, and the Board of Governors of the Federal Reserve System (emphasis added)”.
It is worthwhile to quote from our own Finance Act of 2016, the one that established the MPC: “And whereas the primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth…The Central Government may, if it considers necessary, convey its views in writing to the Monetary Policy Committee from time to time.”
Both, the US Fed and India’s MPC, have very similar goals—price stability with full employment. By experience, the US found it fit to introduce legislation to make the Fed accountable to its own objectives; should we not do the same in India?
How will the introduction of jawabdehi help—can we trust our parliamentarians to ask relevant questions, let alone the right ones? Equivalently, can we trust RBI/MPC to deliver honest (true to its own goals) policy? Can we trust our “analytical” experts to not be cowed down by RBI and be honest in their appraisal—a point also made, in the same context, by CEA Arvind Subramaniam? Three questions—answers to the latter two we know, and that is “no”.
In the US, the Humphrey Hawkins testimony is one of the most important Fed events—it is televised, and both the politicians and the Fed Governors perform beyond expectations. No reason it will not happen in India. All we are saying is “give accountability a chance”. It is a win-win proposal for all, with zero downside—the country is better off, RBI/MPC is better off, and even the “follow RBI” analysts may begin to do some much-needed, independent, and honest analysis. At the time of writing, RBI-MPC’s decision of December 6 is known. Regardless of what the MPC does (rate hike, stay put, or rate cut), my proposal deserves consideration. The only goal of the jawabdehi proposal is to bring about accountability, not rate cuts or rate hikes.