NEW DELHI: A policy, it’s been noted, is but a temporary creed that’s liable to be changed. And while the policy holds, it could be opined, it has to be pursued with apostolic zeal.
Consider, for instance, the latest monetary policy stance and the upward revision, yet again, of the key policy rate and reserve ratio. It’s clear that the policy design is very much as per the book. More specifically, it’s in line with the determinants of monetary policy that has come to be labelled as the Taylor rule. But should the Taylor rule be applied rather mechanistically in the Indian context? It may well have untoward, multi-year consequences.
Now, the Taylor rule in the domain of monetary policy posits that when a shock causes a shift in the inflation rate, the central bank needs to alter (read rev up) the nominal interest rate by more than one-for-one. The idea is to see to it that real interest rates move in the ‘right direction’, so as to restore price stability and sooner rather than later.
The objective of course is to ‘anchor’ expectations of inflation in the medium-term and beyond, and to policy-induce stable growth in a general scenario of only modest price rises across the board.
The weekly figures do suggest that the wholesale price index, close to 12% on a year-on-year basis, has hit 13-year highs. It is another matter that using the y-o-y WPI figure as the operative number for policy purposes can be problematic. It’s not done abroad. Keeping tab of producer price increases can be relatively easy, but there can be much yo-yoing because of seasonal and base effects in y-o-y estimates.
Next, buoyant commodity prices, be it minerals, metals or oil, can disproportionately affect wholesale prices. Be that as it may, the three-year moving average figure for the WPI is now a shade over 7%. Also, the latest data for most consumer price indices peg the inflation rate above the 7% mark. In tandem, the Reserve Bank of India has hiked the repo rate, the rate at which the RBI lends short-term to banks, to 9%. Additionally, the cash reserve ratio for the banking system is to be likewise raised.
However, it needs to be asked whether mechanically applying the Taylor rule makes policy sense. Such rules can doubtless serve as useful benchmarks for the conduct of monetary policy. The real world is surely far too complicated. Monetary policy, of course, ought to aim at maintaining price stability. But the fact remains that the extant inflationary trend is to a large extent supply induced, and especially driven by global commodity price increases.
As the RBI policy review says, on a y-o-y basis about 30% of headline WPI inflation is contributed by minerals oils... It adds that prices of manufactured products have contributed nearly 50% of headline inflation mainly on account of food products, metals and chemicals. And further that primary articles have contributed about a fifth of headline inflation, mainly driven by prices of oilseeds, raw cotton and the like. It’s a moot point whether domestic monetary tightening would by itself bring down headline inflation. More likely that a by and large normal monsoon would dampen the price trend. It is after all hardening import prices, be it of minerals, steel or oilseeds, that are shoring up prices.
Besides, it’s entirely possible that the higher policy rate would jack up interest rates all round. The dearer cost of funds may well affect investment demand and stultify capacity addition, for years. It may not be evident in the immediate period in terms of growth figures. But the quite needless economic damage would nevertheless have been done, thanks to warped policy design.
It is true that there has been the remarkable improvement in both price and output stability observed in the mature economies in the years following the early 1980s. It is also true that the frequency and severity of economic downturns abroad have clearly declined sharply, as has the inflation rate. In parallel, a perceptible shift in the responsiveness of monetary policy did occur at the same time—circa early 1980s. Note that central banks, reflecting much greater focus on inflation, have, generally speaking, been adjusting their policy interest rates in response to inflation by larger amounts and also more readily.
But quite contrary to what dyed-in-the-wool monetarists would have us believe, monetary policy may not have played a particularly large role in achieving the macroeconomic results abroad, sterling though they have been. There’s been much microeconomic change, opening up and reform the world over. It seems quite unlikely that globalisation has played only a minor role in keeping price rises low.
In tandem, there has been much diffusion of information technology and the like that would doubtless have revved up productivity and lowered costs. In any case, just because there has been a seemingly important shift in monetary policy in the mature markets, we need not follow mechanically. Given the weak, underdeveloped financial markets and the poor monetary transmission mechanism here, it’s all the more reason not to do so. Abroad, monetarism is not even considered state-of-the-art, for years. Yet we seem to lap up the monetary-policy equivalent of bell-bottoms.
Consider, for instance, the latest monetary policy stance and the upward revision, yet again, of the key policy rate and reserve ratio. It’s clear that the policy design is very much as per the book. More specifically, it’s in line with the determinants of monetary policy that has come to be labelled as the Taylor rule. But should the Taylor rule be applied rather mechanistically in the Indian context? It may well have untoward, multi-year consequences.
Now, the Taylor rule in the domain of monetary policy posits that when a shock causes a shift in the inflation rate, the central bank needs to alter (read rev up) the nominal interest rate by more than one-for-one. The idea is to see to it that real interest rates move in the ‘right direction’, so as to restore price stability and sooner rather than later.
The objective of course is to ‘anchor’ expectations of inflation in the medium-term and beyond, and to policy-induce stable growth in a general scenario of only modest price rises across the board.
The weekly figures do suggest that the wholesale price index, close to 12% on a year-on-year basis, has hit 13-year highs. It is another matter that using the y-o-y WPI figure as the operative number for policy purposes can be problematic. It’s not done abroad. Keeping tab of producer price increases can be relatively easy, but there can be much yo-yoing because of seasonal and base effects in y-o-y estimates.
Next, buoyant commodity prices, be it minerals, metals or oil, can disproportionately affect wholesale prices. Be that as it may, the three-year moving average figure for the WPI is now a shade over 7%. Also, the latest data for most consumer price indices peg the inflation rate above the 7% mark. In tandem, the Reserve Bank of India has hiked the repo rate, the rate at which the RBI lends short-term to banks, to 9%. Additionally, the cash reserve ratio for the banking system is to be likewise raised.
However, it needs to be asked whether mechanically applying the Taylor rule makes policy sense. Such rules can doubtless serve as useful benchmarks for the conduct of monetary policy. The real world is surely far too complicated. Monetary policy, of course, ought to aim at maintaining price stability. But the fact remains that the extant inflationary trend is to a large extent supply induced, and especially driven by global commodity price increases.
As the RBI policy review says, on a y-o-y basis about 30% of headline WPI inflation is contributed by minerals oils... It adds that prices of manufactured products have contributed nearly 50% of headline inflation mainly on account of food products, metals and chemicals. And further that primary articles have contributed about a fifth of headline inflation, mainly driven by prices of oilseeds, raw cotton and the like. It’s a moot point whether domestic monetary tightening would by itself bring down headline inflation. More likely that a by and large normal monsoon would dampen the price trend. It is after all hardening import prices, be it of minerals, steel or oilseeds, that are shoring up prices.
Besides, it’s entirely possible that the higher policy rate would jack up interest rates all round. The dearer cost of funds may well affect investment demand and stultify capacity addition, for years. It may not be evident in the immediate period in terms of growth figures. But the quite needless economic damage would nevertheless have been done, thanks to warped policy design.
It is true that there has been the remarkable improvement in both price and output stability observed in the mature economies in the years following the early 1980s. It is also true that the frequency and severity of economic downturns abroad have clearly declined sharply, as has the inflation rate. In parallel, a perceptible shift in the responsiveness of monetary policy did occur at the same time—circa early 1980s. Note that central banks, reflecting much greater focus on inflation, have, generally speaking, been adjusting their policy interest rates in response to inflation by larger amounts and also more readily.
But quite contrary to what dyed-in-the-wool monetarists would have us believe, monetary policy may not have played a particularly large role in achieving the macroeconomic results abroad, sterling though they have been. There’s been much microeconomic change, opening up and reform the world over. It seems quite unlikely that globalisation has played only a minor role in keeping price rises low.
In tandem, there has been much diffusion of information technology and the like that would doubtless have revved up productivity and lowered costs. In any case, just because there has been a seemingly important shift in monetary policy in the mature markets, we need not follow mechanically. Given the weak, underdeveloped financial markets and the poor monetary transmission mechanism here, it’s all the more reason not to do so. Abroad, monetarism is not even considered state-of-the-art, for years. Yet we seem to lap up the monetary-policy equivalent of bell-bottoms.
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