11/3/2016

PolicyPuttheKettleOn

Policy Put the Kettle On

Economic Times 2 Nov 2016 C Rangarajan

A new monet ary policy framework has come into operation, which may be described as one of
flexibleinflationtargeting.IthasalegalsanctionandrequirestheRBItomaintainconsumerprice
index(CPI)inflationat4%withamarginof+/2%.Sohowshouldthismandatebeinterpreted?

Todoso,weshouldalsoallaysomeofthemisgivingsentertainedbyopponentsofinflationtar
geting.TheamendedpreambletotheRBIActmentionsthattheprimaryobjectiveofmonet arypol
icyistomaintainpricestability,whilekeepinginmindtheobjectiveofgrowth.Butshouldthefocus
onpricestabilityexcludeconsiderationofotherobjectivessuchasgrowthandfinancialstability?The
answerdependsonhowthemandateisinterpreted.
Inflationtargetingasaschemedemandsthatwheninflationgoesbeyondthecomfortzone,the
exclusiveconcernofmonet aryauthoritiesmustbetobringitbacktothemandatedlevel.Thepolicy
instrument, the repo rate, must be effectively used for this purpose. So long as inflation remains
withinthecomfortzone,theRBImusttakecareofotherobjectives.
Therulesrelatingtotheoperationoftheschemeofinflationtargetingarenotassimpleandrigid
astherulesofthegoldstandard.Underinflationtargeting,wheninflationremainswithinthepermit
tedrange,thereisconsiderablediscretion,andthemonet aryauthority,whichnowincludestheMon
etaryPolicyCommittee(MPC),mustweighinseveralconsiderations.
Theauthoritiesmayraiseorlowerorkeepunchangedthepolicyratedependingontheirassess
mentoftheprospectsofrealgrowth,inflationarytrendsandsometimesevenconsiderationsoffinan
cialstability.Somecriticspointoutthatinflationtargetingdidnotpreventthe2008financialcrisis.
There is a continuing debate whether the crisis was precipitated by monet ary policy failure or
regulatory failure. Countries like Canada and Australia that were committed to inflation targeting
werenotcaughtinthecrisis.
Thelowinterestregimethatprevailedbecauseoflowinflationmayhavecreatedanenvironment
favourableforhighrisktaking.Riseinassetpricesshouldhavealertedthemonet aryauthoritiesand
itwasherethattheyfailedtoact.Inflationtargetingasapolicyframeworkdoesnotpreventraising
thepolicyrateevenwheninflationislow,ifotherconsiderationsdemandit.
Torepeat,whatitonlydemandsisthatifinflationisoutsidethepermittedrangeandifitisex
pectedtopersist,themonet aryauthorityshouldactdecisivelytocontrolit.TheMPChasanimpor
tantroleinthenewscheme.Itmustlookuponitsmandateasgoingbeyondsettingthepolicyrate.It
must be concerned with all the dimensions of monet ary policy consistent with its name. It is not
enoughtodecideonthepolicyrate.

http://www.pressreader.com/

1/2

11/3/2016

PolicyPuttheKettleOn

Itisequallyimportanttoseehowthedecisionwillgettransmitted.TheRBImusttakenecessary
actionstomakethedecisionstickbyexpandingorcontractingliquidity.Inrecentreviews,theRBI
hasbeenconspicuouslysilentonmoneysupply.Thereisnomentionevenontheextentofriseinre
servemoney.Generalstatementsonbeingaccommodativearenotsufficient.
Quiteclearly,hadthedecisionstolowerthepolicyrateinthepastbeenaccompaniedbyreduc
tionsincashreserveratio(CRR),therewouldhavebeenanimmediateeffect.TheRBIitself,inoneof
itsrecentstatements,madeadistinctionbetweentemporaryandpermanentliquidity.
Operationsatthediscountwindowhavelargelyaneffectontemporaryliquidity.Ifpermanent
liquidityistobealtered,thiscanbedoneonlybyachangeinCRRorthroughopenmarketopera
tions.Inshort,whatisbeingemphasisedisthatthesignalofachangeinpolicyratemustbecom
bined with actions that are necessary to influence liquidity. The RBI cannot simply order interest
rates.
Inflationtargetinghasmanydimensions.Butletsfocusononeaspect:topositioninflationtar
getinginthecontextofmonet arypolicyobjectives.Theexistenceofmultipleobjectivesbeforemone
tary policy has always been recognised. When there are multiple objectives, it is necessary to rank
and create a hierarchy. Only then can an institution be held responsible and accountable. The new
monet arypolicyframeworkmakespricestabilityasthedominantobjectiveofmonet arypolicy.This
isawelcomeelaboration.However,theinflationtargetingmechanismdoesnotnecessarilypreclude
considerationsofotherobjectives.
Themechanismisflexibleenoughtotakecareofthem.Itisonlywheninflationcrossestheper
missiblelimit,exclusiveconcernwithinflationcontrolemerges.Electricutilitiesfaceregulatoryand
publicpressuretoachievetwoopposinggoals:makingoverdueupgradeswhileholdingdowncostsand
ratestocustomers.Followinganinvestmentwaveduringthe1970sand1980s,transmissionanddis
tribution(T&ampD)companiesputfarlessmoneyintoimprovingtheirnetworksoverthenextfew
decades. Despite efforts by various standardisa
tion groups, no standards exist for asset manage
mentinthepowerT&ampDindustry.AtmanyT&ampDcompanies,assetmanagementhasmostly
beenamatterofmaintainingandreplacingassetsaccordingtofixedschedulesthatmighthavebeen
establishedyearsearlier.Forexample,itiscommonforT&ampDcompaniestocheckthequalityof
theoilinpowertransformersevery23years,regardlessoftherealrateatwhichoilqualityworsens.
Managing assets in this way has drawbacks. Maintenance programmes vary across companies.
However,sensors,communicationsdevicesandotherhardwarethatallowobjectstobetrackedand
controlledremotelyhavebecomeincreasinglyaffordableandreliable.
TheseshiftsmakeitpossibleforT&ampDcompaniestoretiretheoldmodelofrelyingonspe
cialiststosetmaintenanceschedulesbasedonexperienceinfavourofaflexible,streamlinedandana
lyticallyrigorousapproachthatusesrealtimeperformancedataandpredictivemodelstoguideasset
managementdecisions.
The writer is former governor, Reserve Bank of India From How analytics can improve asset
managementinpowernetworks

http://www.pressreader.com/

2/2