The Money Chakra..!!

In a developing economy, monetary policy has a unique role to play. The aim of Monetary Policy is to have power over the supply of money, often targeting a rate of interest for the purpose of encouraging economic growth and stability. The official goals usually include relatively stable prices and low unemployment.

Money isn't everything... But it ranks right up there with oxygen..!!

The control of monetary policy cannot be handed to politicians with motivation to think for the short term. We are witnessing such a political crisis where our governments have no clue about the disasters they will face which were seeded by them in the near past.

On the other hand, it seems that the Governor of Reserve Bank of India have the operational freedom to practice its mandated goal but the final decision on policy is be decided by a monetary policy committee rather than the governor alone. A majority of the members of this committee are generally appointed by the government. This increase government control over monetary policy.  In the recent Indian context it is noticed that the system provides more than enough room for uncertainty, given the way institutions have been systematically destroyed by political appointments in past few years and giving favors thereafter. It is not ridiculous to say that the government of the day packs the monetary policy committee with people who will bend to its will.

Inflation is taxation without legislation. It adversely affects the purchasing power of people. Especially food price inflation affects the poor and the low income groups harder than the higher income groups. The inflation is not due to supply blockage in food grain. In fact, food grain production in India has reached a record production year after year. The event is recognized to large scale diversion of crop land to bio-fuel production, lose money policy, fiscal credulity and rise in fuel prices. Fuel price has definitely contributed to food price hike in India. But the other reasons do not apply to the Indian economy. Deficit financing is on a harness. So is monetary policy. In order to discipline the rising food price index, the RBI is trying to control money supply in the economy by raising repo-rates which discourages investment and encourages savings, thereby dropping demand. However, the increase in the interest rate has done little to control food inflation. On the contrary, costlier loan has held back the growth rates of Gross Domestic Product and industrial output.

Over a fixed time horizon, inflation expectation is a mirror which shows the credibility of the monetary authority’s commitment to stated objectives. The effectiveness of monetary policy is likely to be greater if inflation expectations remain secured. A sustained rise in expectations in the short-run runs the risk of heightened inflationary pressures in the medium-term. Hence, central banks have an incentive to understand how inflation expectations are formed. It is widely believed that imperfect information regarding central bank intentions has been one source of inaction in the formation of inflation expectations which happens due to leverage of government over the institutions like RBI. It’s a high time that the conduct of the monetary policy should be handed to technocrats who can take the longer view rather than politician who always intended to think for the short term. The basic issue with the monetary policy is time-inconsistency problem, which in practical terms often means increasing tolerance for inflation in pursuit of growth. Such unfairness can be minimized only when there is nominal government leverage over monetary policy.