Opinion – Should the government have a say in the Monetary Policy?

Before answering this question, let us first take a quick look at the present formulation of the Monetary Policy.

Current Scenario: Monetary Policy of India is framed by the RBI headed by the Governor. He/She will be advised by the Deputy Governors and a Technical Advisory Committee for the Monetary Policy, but the advice rendered is not binding on the Governor.

Though the RBI doesn’t define the objectives of the monetary policy, some of them can be discerned as the following:

  • Price control – inflation targeting.
  • Ensuring adequate credit flow to sustain economic growth – growth targeting.

Problems with the present Monetary Policy:

  • The monetary policy must go hand in hand with the fiscal policy, but often we see dissent between the two, due to the lack of adequate coordination between the government (Ministry of Finance) and the RBI. As a result the Indian economy is not realising its full potential. For example, till December 2014, the RBI refused to accept the demand of the government to lower the interest rates to stimulate the economy. Keeping aside the merits and de-merits of this decision of the RBI, the dissent between the two is evident. The government which runs on the people’s mandate should definitely have a say in the monetary policy.
  • The present monetary policy holds an element of unpredictability as the guidelines of the monetary policy have not been specified. Having a predictable policy will ensure stability in the economy. Although some amount of unpredictability is required in the monetary policy, the present system swings far too much towards unpredictability. For example, the the RBI refused to lower the interest rates until Jan 2015 despite the industrial expectations of an early cut (as the inflation got tamed since June 2014).
  •  Also there is no adequate transparency and accountability in the formulation of the monetary policy. This needs to be addressed to improve the governance in the formulation of the monetary policy.
  • Recently, the RBI accepted Urjit Patel Committee’s recommendation of adopting CPI as the nominal anchor of the monetary policy. This makes sense at a time when India is fighting the inflation, but this doesn’t make sense in the long term.

It is in this regard, several committees like Financial Sector Legislative Reforms Committee (FSLRC) and Urjit Patel Committee, have recommended the establishment of a Monetary Policy Committee to formulate the monetary policy. The monetary policy shall be formulated by this committee on the basis of majority vote and they shall be held accountable.

Composition of Monetary Policy recommended by FSLRC:

  • Chairman (Governor)
  • Deputy Chairman (Dt. Governor)
  • 5 External full time members to be appointed by the RBI.
    • 2 of them must be appointed after seeking the opinion of RBI.
  • 1 representative from the government with no voting rights.

Composition of Monetary Policy recommended by Urjit Patel Committee:

  • Governor
  • Dt. Governor
  • Executive Director of the monetary policy
  • 2 External full time members appointed by the RBI

Since Urjit Patel Committee was constituted by the RBI, its recommendations ensure the domination of RBI in the monetary policy 😉

No doubt, there should be greater convergence between the monetary policy and the fiscal policy. For this it would be more appropriate to ensure that the government has a say in the formulation of the monetary policy as it will ensure that the concerns of the government backed by public mandate are addressed in the formulation of the monetary policy. In this regard, the recommendations of the FSLRC would be more appropriate to be implemented.

So, yes, the government should have a say in the formulation of the Monetary Policy.

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