RBI vs Govt: Is centre’s ‘nudge’ a precursor to legislative action or the exercise of its legitimate power?

By: | Published: November 17, 2018 1:36 AM

Can a ‘nudge’ be treated as a precursor to legislative action or the exercise of legitimate power that one entity has over the other?

Hence, if a company deducts a single day salary of all employees for say, flood relief, but adds that if one does not want to contribute, they could say so, the company has actually nudged its employees into donating one day salary.

By Madan Sabnavis
Chief economist, CARE Ratings
Views are personal

Behavioural economics has caught on these days with a lot of theory going back to how the human mind thinks. Game theory now dominates not just politics but also business decisions and has its roots in behavioural economics. It can also be argued that conventional economic theory always had behaviour in mind even when the rudimentary demand theory was put forward when the ceteris paribus conditions were relaxed to accommodate tastes, demonstration effect and so on. Within this ambit of behavioural economics is the theory of ‘nudging’ which got Richard Thaler the Nobel Prize in 2017. We can actually see this in action in our context at the highest level—policies.
Simply put, nudging is a way to get people to do something which you want them to do. An example given is that if you ask people to contribute to a post-retirement fund, there will be a tepid response.

However, if the government puts you in the scheme and then asks you to opt out if you want, then you are more likely to remain. Therefore, in a democratic system, by defining the choice matrix in a different way, you can get the result. Hence, if a company deducts a single day salary of all employees for say, flood relief, but adds that if one does not want to contribute, they could say so, the company has actually nudged its employees into donating one day salary.

Now, if one looks closely at the government-RBI so called standoff, there has been no compulsion so far and whatever has been done has been through nudging. Let us start with the monetary policy story. All governments want RBI to lower interest rates. Yet, the decision taken is by the central bank. Several FMs have let their emotions flow on this issue. One way to nudge the rate is to have a MPC. But the composition of the MPC came as a surprise as it got in economists and not bureaucrats as members along with RBI experts. Therefore, there is still dissatisfaction from the government side, where the blame cannot be put on the central bank as it is a committee decision. The 4% target and band has brought in a lot of subjectivity with inflationary expectations coming in. The nudge has not been constructed the way it should have been to get a favourable response.

Next, some of the decisions taken on, say, IBC and NPA resolutions can be related to nudging. The approach has been to keep making public statements that the central bank should relax the rules so that the power sector can breathe. RBI has remained intransigent in its view. The nudge has been buttressed by getting in experts who are from the government. So we have members of the NITI Aayog or PMEAC or the Department of Economic Affairs comment relentlessly on this issue as also the PCA framework. The issues are analysed in detail and while it may tend to be one-sided, the view is finally that there should be flexibility in the central bank’s stance which is argued in a very convincing manner.
A different kind of nudging was used by the government to ask RBI to do something about enhancing the flow of funds to the SMEs. After subtly talking about the subject, the government announced a package for this sector which also includes interest rate subvention. The message sent is that the government has done its bit which includes the subsidy which should now be followed up by the central bank through appropriate policy announcements.

The media is also a very effective medium to use for nudging. Whenever there is a controversy public opinion becomes important and here Thaler would argue that the audience gets to hear the arguments and then decides which is more appropriate. The government has played its role by having spokespersons or qualified supporters argue the case out. Both visual and print media matter and having a series of articles to say that high interest rates militate against growth is a way of sending a message to RBI that the repo rate should be lowered. This is where neutral parties in the form of critics and so-called experts have a role to play in talking about the other side. The fact that RBI does not respond could make the arguments sound heavily tilted in one direction.

Nudging is hence becoming a very important tool today to influence policy making. The issue on using the reserves of the central bank as transfers to the government also fits into this theory. Presently, it is only a nudge with a clarification being made that there is no compulsion with the idea being nascent in form. The response has not been coming and the hype created is that this is an important issue which can be taken up in the board meeting. This becomes a second nudge meaning, thereby, that the unwillingness to transfer the reserves, which belong to the people, will be reviewed by the board. It would otherwise be too much of a coincidence that the issue of having an ideal reserves to assets ratio for a central bank should be brought to the table now. The view that the public has now is that the money, if transferred, can be used for the betterment of the country with roads being built. There is no counter view to say that while the transaction is a simple accounting entry, it would mean printing more money as the balance sheet is largely notional for any central bank.

Therefore, can a ‘nudge’ be treated as a precursor to legislative action or the exercise of legitimate power that one entity has over the other? In this case it could mean government exercising its prerogative by being the virtual owner? It is interesting as to how the game gets played now. In a normal game between two government arms, where the finance ministry and RBI would be the two players in our case, a typical result is a game where each one anticipates what the other will do and forms a strategy accordingly. The purpose is to have all the steps ready and play the cards as it unfolds.
Nudging has hence become an integral part of directing policy formulation. Governments are nudged to raise MSP or cut expenditure or glide along the FRBM path. RBI is nudged to different things at different times. This will be an ongoing game. The interesting part is when the nudge becomes a shove through exercise of the clinching factor, i.e., legitimate power.

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