RBI vs GoI: Neither Reserve Bank nor the government have done an ideal job of managing the economy
Neither RBI nor the central government has been doing an ideal job of managing key aspects of the economy. If RBI failed in bank regulation when bad loans were being made, the government’s failure to allow or enable banks, especially public sector banks, to do their jobs well is also a cause of the problem.
One of the slogans of the winning party in India’s last general election was “minimum government, maximum governance.” This possibly cryptic pronouncement had a natural interpretation in the context of India’s history of government functioning. “Minimum government” suggested a reduction in unnecessary government interference in the daily lives of citizens, whereas “maximum governance” suggested greater effectiveness in delivering public services that the government is supposed to provide. The main implied sphere of these changes was in the economy—the message was not about general issues of personal autonomy or protection of human rights, as far as I can judge (based on the ideology of those making the promise).
In some cases, like reducing petty corruption among government employees, and speeding up delivery of services, the way forward is rather straightforward, conceptually, even if difficult to implement in practice. But in other cases, working out rules and institutions for effective governance is much more challenging. There is no better illustration of that than in the case of the Reserve Bank of India (RBI). The RBI, like any other central bank, is in an important position as overseer of the nation’s monetary and financial health. In particular, the proper conduct of monetary policy is vital for ensuring that inflation does not get out of hand, since soaring inflation can damage the economy as a whole, besides hurting the poorest the most.
Over the last few decades, an academic consensus evolved that controlling inflation is a central bank’s main responsibility and that it needs to be given the autonomy to pursue that goal effectively. In particular, it needs to be insulated from the pressures of politicians who may want easier money for short-term political gains, at a long-run cost that is beyond their political horizon or calculations. This is easy to understand. One complication is that even central bankers may reasonably care about output losses from squeezing money and credit too hard. So setting goals is not always straightforward. Implementation is complicated by lack of information about the expectations that economic actors have about inflation (which affects what the optimal policy should be) and about how changes in policy variables such as central bank interest rates feed into economic activity. Mistakes can be made, and sometimes are, even in “advanced” economies.
Another complication is that the central bank does quite a few other things, some closely related to the conduct of monetary policy, others not so much. Supervising and regulating the banking sector, where money is effectively created and circulated through bank deposits and loans, is a critical function of a central bank. Managing the exchange rate, government debt and other aspects of financial markets are also part of the central bank’s charge in India, though not always in other countries. This is important to realise—central bank autonomy does not have to mean that it keeps having control over what it has historically managed.
In India, there is a case for rethinking what the RBI does. Autonomy over monetary policy and regulation of banking seem unequivocally appropriate for it. But maybe public debt management should be handled by another independent agency, or maybe even by the finance ministry. The case for independence or autonomy is typically based on insulation from political pressures, not just in terms of corruption, but also in terms of actions that are not consistent with long-run national welfare. Expertise from long-run specialization is also a consideration. A meritocratic bureaucracy is generally considered a good idea from both these considerations, even though bureaucrats working in ministries cannot have the same degree of autonomy as independent regulators.
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