In a reformed Monetary Policy Committee, members must be at odds with each other

It is about time that MPC reformation takes place along with that of the RBI.

“Spirit of investigation, and not advocacy,” is probably the defining statement of effective monetary management. The statement was brought forward by the then Deputy Governor of the Bank of England, Mervyn King, during his 2002 speech. Echoing the findings of Princeton professor Alan Blinder, King was most likely describing the knowledge-pooling approach monetary committees successfully utilise while reaching critical decisions. Since interest rate setting is perhaps one of the most important decisions taken in the name of public welfare, monetary economists such as King and Blinder attach so much importance to committees and not experts alone.

This is because when multiple minds collaborate and search for an optimal solution, decision-making becomes much more efficient. Consequently, by virtue of being a college of experts, a committee operates through a spirit of investigation and does not seek to impose a certain belief on the governed. Perhaps why the results achieved through knowledge-pooling or consensus, is easier to accept in a democracy.

Nevertheless, the design of the committee must be deliberated by respective policymakers with sincerity because the former’s nature and composition decide the efficacy of a policy decision. A committee must therefore never become a tool of advocacy, in cahoots with a government’s agenda. This is precisely the reason why there is a lot of debate out there pertaining to the ideal number of members in an MPC and the consensus-building approach that must be followed to reach a decision on interest rates.

Consensus Through Coercion

Pertaining to India’s Monetary Policy Committee (MPC), Section 45Z of the RBI Act elaborately defines the composition of the committee and the respective voting rights of members. Accordingly, the MPC comprises six members, equally divided between representatives of the RBI (including the governor), and subject-matter experts. Importantly, while all appointed members are free to deliberate and have a vote, the consensus-building approach is mandated to be driven by ‘majority votes,’ and not by ‘unanimity.’ What this means is that Indian monetary economics is likely a function of a consensus through coercion, in a dignified sort of way.

This brings us to the question pertaining to the strategy behind the figure of six, which could have been five or seven members instead. A potential explanation for the above predicament lies in a Jury, the design of which is often emulated by monetarists to study optimal MPC designs. Just as a Jury, which comprises members of the public assembled to decide the fate of the convicted, an MPC is a representative body established to decide the fate of consumption by modulating the cost of capital. While the two committees exist for totally different reasons, surprisingly they both function similarly.

Here a bit of game theory hence comes into play. In 1956, sociologists EF Borgatta and RF Bales contended that odd-numbered groups are superior as compared to even-numbered. While their view was applicable to any group, subsequently, monetarists have increasingly used the Borgatta-Bales theory to design MPCs. The contention here is that a committee with 5 or 7 members will be more effective in monetary management than a committee with 4 or 6 members.  The general view is that in a ‘majority votes’ setting (like in the case of India), a consensus can be reached faster in an odd-numbered composition via the principle of majoritism. Members can therefore quickly divide themselves into concurring or opposing groups and reach a conclusion. But this approach can be successful only in cases where all members have no biases or common affiliations: A condition not applicable to India, given the fact that half of our even-numbered committee is affiliated to the RBI.

Game theory teaches us that in case an MPC reformation results in an odd-numbered committee, members may or may not reveal their true opinions about the economic realities and may go with the flow, pacifying the dominant side. Since the Indian law of the land requires written commentary from each MPC member, sometimes it becomes important to remain with the consensus and not be termed as the odd-man-out, amidst intense public scrutiny. Nevertheless, as a saving grace, there will always be at least one member in an odd-numbered committee who might act as a swing variable, disallowing other members to predict a reasonable outcome. But this can never happen in India’s even-numbered committee, as three members will always come prepared with a consensus.

Adopting Mean Signal 

Economists define this preplanned consensus as the “Mean Signal” of a particular group, which ultimately seeks to impose its narrative on the entire committee. So far, all MPC minutes of meetings point towards the adoption of this “Mean Signal,” as the ‘final outcome’ of all deliberations, irrespective of what the other three think. This “Mean Signal” in India is that of the RBI – which leads us to question the effectiveness of a committee, and the narrative of investigation, which clearly does not exist. This is also perhaps the reason why India must move toward the odd-numbered MPCs. Therefore, it is about time that MPC reformation takes place along with that of the RBI.

Following the arguments presented by this author in the previous pieces on RBI reformation, the Indian MPC must rethink its composition and not only look at an odd-numbered set-up but also the kind of representation it needs. Given the sheer diversity of the Indian macroeconomy and the complexity encountered in policymaking, this author is of the view that a reformed MPC must include representatives of the financial institutions, along with the current composition. These additions to the MPC game will act as a new signal, which can potentially dislodge the imposition of the “Mean Signal,” by RBI representatives. Care must be taken that this new class of MPC members must be odd-numbered to change the overall dynamic of the committee. Knowing the presence of a swing variable, committee debates can then become more earnest, and unbiased, leading to the achievement of a true investigative spirit in the policy debate.

(This is the third of a series looking into reforms required at the RBI to make it more effective in a changing India. Here is part one and part two.)

Karan Mehrishi is an economist, specialising in monetary economics and fixed income. Views are personal and do not represent the stand of this publication.