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Theimportanceofpolicypredictability
Ithashelpedeconomicagentsmakeinformedfinancialdecisions
SoonaftertakingoveraschairmanoftheFederalReservein1987,
AlanGreenspanfamouslysaidthathehadlearnedtomumblewith
greatincoherence.Greenspanwasnotaloneamonghispeersto
havemasteredthisdarkart.Untiltheearly1990s,theconventional
wisdomamongcentralbankerswasthattheyshouldbecrypticwhile
speakinginpublic,andsayaslittleaspossible.
Butthingshavechangedsincethen.Communicationhasnow
becomeanimportanttoolinconductingmonetarypolicyinmost
countries.Clearcommunicationhashelpedinmanagingmarket
expectations,especiallyintheaftermathoftheglobalfinancialcrisis,
andwasinstrumentalinrestoringorderinfinancialmarkets.Greater
focusontransparency,communicationandguidancebycentral
bankshasresultedingreaterpolicypredictability.
Illustration:Jayachandran/Mint

However,giventhestateofthefinancialsystemandtherolethatthe
accommodativepolicyinadvancedeconomieshasplayedin
pushingupassetprices,analternateemergingviewisthatpolicy
decisionsarebeingdominatedbysourcessuchasfinancialmarkets.TheReserveBankofIndia(RBI)initslatestFinancialStabilityReport
alsoraisedthisissueandnoted:thereisaneedtorethinkwhetherthecentralbanksshouldalwaysactinapredictablewayandnever
surprisethemarkets.Itis,therefore,importanttoassessthecostsandbenefitsoftoomuchassurancetomarkets.
Theimportanceofpredictabilityinmonetarypolicycanperhapsnotbeoverstated.Inthesummerof2013,BenBernanke,thenchairmanof
theFederalReserve,surprisedthemarketbyindicatingthattheUScentralbankcouldstartreducingthequantumofassetpurchases,or
quantitativeeasing.Consequently,financialmarketsallovertheworldwentintoatailspin.Indiawasseverelyaffectedbythistapertalkand
therupeewasinafreefall,thoughdomesticmacroeconomicconditionswerealsotobeblamedforanearcrisissituation.
RaghuramRajan,aftertakingoverasgovernorofRBIinSeptember2013whenIndiawasstillstrugglingwithtapertantrumvolatility,also
emphasizedtheneedfortransparencyandpredictabilityinpolicythoughheaddedthatthisdoesnotmeanthatthecentralbankwillnever
surprisethemarket.RBIindeedsurprisedthemarketwithoutofturncutsinpolicyratesin2015.Thisonlyresultedinconfusionamong
marketparticipants.MonetarypolicystanceinIndiahasnowbecomemorepredictablewiththeadoptionofinflationtargeting.
Atthegloballevel,predictabilityinmonetarypolicypathandbettercommunicationbycentralbankshavehelpedeconomicagentsmake
informedfinancialdecisions.Itisdifficulttoarguethatbringinginsomeunpredictabilityorsurprisingthemarketwillhelpcentralbanks
achievepolicyobjectives,includingthatofmaintainingfinancialstability.
Theproblemwithmonetarypolicyintheindustrialworldiscertainlynotoneofassurancetothemarket.TheFederalReservewasactually
abletoendquantitativeeasingandeventuallyraiseinterestrateswithoutmuchtrouble,simplybecausemarketsknewthestanceandthe
pathofthecentralbank.HadtheFederalReservedecidedtoendeasingandraiserateswhenBernankefirstairedtheideaofthetaper,
thingscouldhavebecomeveryuglyforboththefinancialmarketandtheglobaleconomy.
Tobesure,theproblemwithmonetarypolicyismuchdeeper.
Centralbankshavedonemostoftheheavyliftingintheaftermathofthefinancialcrisisandhavestretchedthelimitsofwhatmonetarypolicy
cando.Asaresult,returnonincreasingaccommodationhasbeendiminishingandchannelsofmonetarytransmissionarenotworkingas
desired.Policysurprisesatthisstagewillneitherhelptheeconomynorenhancethecredibilityofcentralbanks.Whatisperhapsneededis
reexaminationofthepolicypaththatcentralbankshavetaken,preferablyinacoordinatedfashion,sothatexcessesinfinancialmarketand
elsewherecanbeavoided.Centralbankswoulddowelltoreservepolicysurprisesforextremecircumstances.Itshouldbeusedtoquell
instabilityandnottoinducevolatility.Itispossibletomakepolicychangesinapredictablemanner,ashasbeenshownbytheFederal
Reserve.
Shouldcentralbankssurprisethemarketoften?Tellusatviews@livemint.com

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