Opinion
RBI shouldn’t play the game of ‘For your eyes only’
Summary
RBI’s secrecy over its failure on inflation control last year risks causing an information deficiency and making space for ‘common noise’ in ways that could complicate its own policy.
The Reserve Bank of India’s insistence on keeping ‘confidential’ its communication to the government explaining why inflation stayed for three quarters above its 6% upper limit under the flexible inflation targeting framework that India set for itself in 2016 is perplexing and vexatious. In the past, RBI refused to answer Right-to-Information queries on demonetization: why conversion of old currency notes had not been allowed until 31 March 2017 (as had been initially declared by the Prime Minister), the time it would take to replenish currency notes, and whether the finance minister had been consulted before the announcement. For its refusal, RBI cited Section 2(f) of the RTI Act, which let it classify such queries as “not information" under our transparency law.
In the present instance, the right to RBI’s privacy in response to a Mint RTI query has been justified on grounds of national interest under Section 8(1)(a) of the RTI Act. RBI had cited the same clause in 2016 while refusing to answer an RTI query about the reasons behind the overnight scrapping of almost ₹20 trillion worth of currency. So, the reasons for demonetization and RBI’s inability to achieve its inflation mandate have been treated at par. This is truly flummoxing!
The vexation on monetary policy arises from the expectation that in unconventional times, the value of the central bank’s role in managing the expectations of economic agents (comprising consumers, investors, businesses, financial market participants, etc) and in maintaining policy predictability increases sharply. The Rational Expectations Hypothesis posits that economic agents form their expectations (and make decisions) based on available information, together with past information. Such economic decisions based on rational expectations are often correct. This hypothesis further posits that correct decisions reinforce similar expectations in the future. Take the case of the 2008 financial crisis in the West and the US Fed’s Quantitative Easing programme, which reduced interest rates for more than seven years, triggering perverse expectations of persistently low interest rates among people, which led to the ineffectiveness of US monetary policy.
The non-achievement of India’s inflation mandate is plainly visible. It would be reasonable to assume that even laypersons could have attributed persistent high inflation in 2022 to the post-covid economic environment and uncertainty caused by the Ukraine-Russia war. Better aware economic agents would have been guided by the minutes of Monetary Policy Committee meetings in their formation of expectations, analysing factors such as India’s net commodity importer status together with high commodity prices, exchange rate volatility, covid-relief stimulus in advanced economies and the European conflict’s supply disruptions as reasons for RBI’s deviation from the mandated inflation target.
In this scenario of humdrum expectations formation, RBI’s veil of secrecy has the potential to lead to ‘common (or public) noise’. Such noise, which refers to all agents suffering from the same imperfect interpretation of an announcement, is traditionally attributed to problems in the language used by policymakers concerning the policy regime. It can, however, equally and paradoxically occur when RBI refuses to share information. Such noise could take the form of speculation over its ability to manage inflation in the future, especially in a pre-election year, when fiscal dominance may be seen as outweighing monetary policy goals. In turn, this could lead to the unintended consequence of anchoring inflationary expectations at a higher level, making the task of inflation management even more difficult.
Clear public communication is a strategic weapon that helps central banks secure the ‘legitimacy of policy’. Such communication would help economic agents take decisions aligned with expectations of inflation being in line with the inflation target. The impact would be a more stable macroeconomic environment. Equally importantly, clear public communication also helps the central bank become more accountable, which grants it credibility and builds public confidence. Without sufficient information, economic agents are likely to spend considerable energy and effort seeking precise information. It has been suggested that providing agents with detailed information through multiple sources is a way to avoid common noise, as individual misunderstandings would cancel out in the aggregate. Further, when such communication is precise, it mitigates the possibility of inefficient market externalities.
And what of RBI’s fear that the information sought, if placed in the public domain, is likely to hurt national integrity? Is it a fear of being seen as ‘not in control’, which could lead to reduced confidence in Indian financial markets and institutions? The central bank should reexamine its role and assign greater weight to appropriate policy communication, rather than simply devise policy instruments. This involves storytelling, with RBI’s effectiveness enhanced by an ability to offer a coherent narrative regarding certain policy decisions, their failure, etc, based on the economic context. As stated by a former senior deputy governor of the Bank of Canada: “Like the baseball umpire says, ‘There’s strikes and there’s balls, and I calls ‘em as I sees ‘em’."
Calling a spade a spade is important, rather than using it to dig oneself a ‘policy grave’.
These are the author’s personal views.
Tulsi Jayakumar is professor of finance and economics and executive director, Centre for Family Business & Entrepreneurship, Bhavan’s SPJIMR
