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