Since the 1980s, central bank independence has become a religion
Arvind Subramanian is touring India promoting his book, ‘Of Counsel’. In a recent event in Chennai, he had clarified the word ‘Draconian’ which he had used to describe the withdrawal of the 86% of the notes in circulation in November 2016. He simply meant that it was a massive shock. The Indian media had gone to town overplaying that word in an all-too familiar display of craven political bias. It is yet another reminder of the need for cultural and context sensitivities for economists. Not that Subramanian lacked either. When I asked a former civil servant about the requirements of being a chief economic advisor, he said that Subramanian came very close to being one. That was a generous tribute.
Subramanian had documented an instance where his advice to the government rendered before the Paris convention on climate change was mischievously portrayed by a newspaper as advocating surrender to the Western powers with an accompanying brooding and conspiratorial picture of his to boot. Given these two experiences, it is good that he documents an instance where the finance minister made substantial corrections to the chapter on JAM (Jan Dhan Yojana, Aadhaar and mobile payments) in the Economic Survey 2014-15. In Subramanian’s words, “the chapter…could well have been written by a Washington Consensus-inspired economist, deserving today’s damning sobriquet ‘neo-liberal’". In the end, the chapter was rewritten bringing out the equity objective of the JAM innovations—prevention of exclusion of deserving poor beneficiaries from government schemes. Yes, economics is about people and not about elegant theories. That is for physical sciences.
Advocates of ‘liberal economics’ are opinionated. They ignore evidence and experience on the benefits and costs of its core tenets. They are balanced budgets, liberal international trade, international capital mobility and institutional independence, specifically, the independence of the central bank. Each and every one of these elements has its place in given contexts, at best. At worst, some of them are undesirable (think free capital flows). However, the advocates of liberal economics have elevated these tenets to those of a gospel—inviolable and unexceptionable.
Take central bank independence, for example. One of the papers that is worth reading in this context is ‘Origins of central banking’ by Lawrence Broz published in 1998. Monarchs and later governments set up banks to ensure that they could finance wars in a manner that reassured the creditors of repayment. Being financiers to the monarchs conferred special privileges and the notes issued by such an institution were used by other banks as reserves. That is how they became central banks. Further, the bank’s ability to ensure a credit boycott for the government brought down the cost of borrowing for the government markedly. This was particularly true in Britain which has the world’s second oldest central bank. However, the government could still pressure the Bank of England to finance the Napoleonic wars through inflation. Inflationary financing was constrained by the gold standard rule. During the century when this rule was in force, the inflation rate in England was indistinguishable from zero.
Since the 1980s, central bank independence combined with inflation-targeting has become a religion. The Reserve Bank of New Zealand was the first one to go with inflation targeting and the German Bundesbank was probably the only truly independent central bank until then. That was dictated by the German history of hyperinflation in the 1920s and again in the 1950s. Three years ago, a survey-paper showed that inflation targeting by RBNZ did not play a role in the formation of inflation expectations among either the so-called informed public or the general public. Their visits to the petrol pumps and supermarkets did. In the meantime, increases in the prices of consumption basket of goods and services moderated since the 1980s because monetary policy reacted to incipient signs of acceleration in wages. This was compounded by increased workers’ anxiety about jobs caused by globalization, reduction of labour bargaining power, advent of technology and the rise of China as a global trade hegemon that exported deflation and disinflation to developed nations.
Therefore, while claiming credit for an outcome in which they perhaps had very little role to play, central banks, having won their independence from democratically elected governments, willingly became captive to the interests of financial markets and fomented inflation in asset markets. This has left millions with little savings, resulted in concentration of economic and market power in few hands and cleaved societies. Thus, after four decades, liberal economics does not have much to show for its net benefits to the society. For a period, it appeared to create prosperity but viewed over a longer time and after reckoning social costs, its limitations and disadvantages come into sharper focus.
Western economies did not become prosperous adhering to the tenets of liberal economics. The time has come to save liberal economics from ‘liberals’ or to bury it.
V. Anantha Nageswaran is the dean of IFMR Graduate School of Business (KREA University). These are his personal views.