Moneycontrol Pro Panorama | RBI flags emerging challenges to monetary policy framework

RBI MPC

Dear Readers,

Have you ever thought about what it’s like to be a central banker? They say it’s tough.

As Raghuram Rajan famously said, monetary policy is like juggling six balls; it isn’t just about raising or lowering interest rates. I assume most people who have donned the hat of a central banker at some point in their lives wouldn’t dispute Rajan on this.

Even as outside observers, you and I can imagine that this isn’t an easy job. At the high table of six, when you sit down for the final call, there are many moving parts before you—each with its own pressing case.

And what do you have in your arsenal?

You can tinker with interest rates and play with liquidity to keep the enemy engaged. That’s pretty much it. You also need to have a thick skin to face the questions.

No matter what you do, something always doesn’t add up.

And then there are growth concerns. The MPC has faced criticism for keeping interest rates too high for too long, which has resulted in less-than-potential economic growth.

Therefore, we need to be sympathetic to Michael Patra, one of the four deputy governors of the central bank, when he says that inflation targeting needs to be more flexible, robust, realistic, and nimble.

Patra’s exact words at the recent RBI conference: 

“Inflation targeting policy frameworks of the future need to be more robust, realistic, and nimble, while exploiting synergies with prudential, fiscal, and structural policies and leveraging technological transformations. Adaptability and flexibility built into the framework would ensure that the central bank can nudge the economy toward desirable societal outcomes.”

For the last eight years, the MPC has been working with an inflation target of 4 percent, with a tolerance band of two percentage points on either side.

Truth be told, the panel hasn’t had a particularly memorable track record in fighting inflation.

In fact, last year, the RBI had to write a letter to the government when inflation crossed the upper tolerance band of 6 percent for three consecutive quarters, marking a significant moment where the MPC had to explain its failure to meet the inflation target.

The MPC has struggled to manage inflation. Even after 10 consecutive policy meetings with no rate changes, inflation remains elevated -- and elusive from aligning with the 4 percent target -- due to soaring vegetable prices, something the central bank has no control over.

The food group, which constitutes 46 percent of the CPI inflation basket, remains largely a mystery to the six members at the MPC table. Even in the latest CPI inflation data, food price spike is the villain.

Patra’s Lament

It is in this context, the deputy governor in charge of monetary policy is highlighting fresh risks to inflation targeting, including climate change and digitalisation.

Apart from the climate risk challenge, Patra also noted that monetary policy transmission could be dampened if digitalisation leads to a shift in credit supply from banks to less regulated or unregulated non-banks, or by offsetting reductions in bank deposits.

As this article argues, blaming technology, AI, and digitalisation for regulatory inefficiencies or banking system failures is illogical. That shouldn’t be a reason to discourage technological innovation.

What is the key takeaway from Patra’s comments? To my mind, this signals the RBI’s acknowledgment that the current inflation targeting framework is less realistic and that a new, flexible one is needed.

Whether you call it an elephant or horse, the inflation threat is very much around—hurting the average Indians—and remains a question mark to the policymakers. No inflation joke can pacify the poor households struggling to make ends meet.

Shifting the inflation goalpost now will make the MPC’s job easier, but will eliminate whatever credibility is left in this much-hyped framework.

Also, I’m reading Manas Chakravarty’s piece on this year’s Economics Nobel Laureates’ dystopian view of artificial intelligence and Rajrishi Singhal’s piece that argues why all is not well with small finance banks. 

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Dinesh Unnikrishnan Moneycontrol Pro