“Transparency” and “openness” are normative words that have a positive ring to them. It is hard to declare oneself against transparency and openness. Therefore, the onus is on those who call for transparency and openness to be sure of the purposes behind their call.
Recently, the International Monetary Fund, as part of its annual consultation with India, released a study on the transparency of the communication from the Reserve Bank of India (RBI). The study found RBI wanting, compared with other central banks. Many others in India joined in the criticism of the central bank. They could have waited. New evidence suggests the need for an honest debate, at the minimum, on the issue with national interest as the guiding principle.
A paper, prepared for the US Monetary Policy Forum, on the losses from the mortgage market meltdown in America (Leveraged Losses: Lessons from the Mortgage Market Meltdown draft dated 29 February 2008 by David Greenlaw, Jan Hatzius, Anil Kashyap and Hyun Song Shin) provides an opportunity to examine more thoroughly the claimed benefits and virtues of monetary policy transparency.
The authors systematically arrive at a quantitative assessment of the impact on economic growth of the current and potential defaults in sub-prime mortgages alone. They repeatedly stress that their estimates are conservative. To keep their analysis tractable, they ignore losses in prime mortgages. They ignore potential contagion in commercial real estate, auto and credit card loans. Estimation of second-round effects on economic growth from contraction in the balance sheets of leveraged financial institutions (investment banks and hedge funds) is skipped as well.
The authors leave it to the readers to draw their own inferences. What I took away on reading that article is that the US would have to be very lucky to avoid a Japanese-style lost decade. Of course, the Federal Reserve would pull out all stops and so would the government to ensure that America does not suffer such a prolonged economic stagnation. The federal funds rate would likely drop below 1%, last seen in June 2003.
These actions would inevitably result in higher inflation in the rest of the world. The US, despite a growth slowdown, would not be spared either. The impact on the dollar is too obvious to be reiterated here. We simply ain’t seen nothing yet.
In addition to all of these, there is a nugget of insight tucked inside. The bulk of the subprime origination, on a scale never seen before, started in 2004. That is the year the Federal Reserve under chairman Alan Greenspan started its transparent and measured rate increases from a low 1%.
What exactly did this transparent normalization of interest rates achieve? Arguably, it caused credit to explode instead of contracting it. Instead of tighter cost of capital leading to reduced risk-taking, it saw leveraged institutions expand their balance sheets aggressively. Of course, China saw to it that the cost of long-term borrowings did not rise with its aggressive purchase of US debt.
The questions we have to ask ourselves are these: Did transparency encourage reckless risk-taking? Did the Federal Reserve remove policy uncertainty and therefore the need to hedge against it? What were the benefits of open and transparent monetary policymaking for America? Can they be quantified?
Counterfactually, what are the costs of non-transparent monetary policymaking? In India, in particular, if it prevented domestic and foreign financial institutions from importing the pernicious practices and products of the leveraged financial institutions of Wall Street, isn’t it a good thing?
More precisely, what really are the economic costs of non-transparent policymaking? Finally, in the context of monetary policymaking, what does transparency mean and what are the steps it consists of?
To put it bluntly, a transparent (yes!) and unbiased debate on the subject is required. I would like to leave the final word to Daniel Thornton of the Federal Reserve Bank of St Louis who published a working paper in May 2003 on the subject of monetary policy transparency (Monetary Policy Transparency: Transparent about what?): “Transparency is desirable if it enhances the effectiveness of policy and is not if it does not.” Discussion should be framed and policy judged against this criterion only.
Recent developments in America provide India the rare opportunity to fashion its own idiom without being force-fed Western practices and developments in the guise of market economics. Indians must grab the opportunity with both hands instead of mindlessly allowing imported paradigms to dictate policy, practice and debate.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org