Monday, August 21, 2006

Indian monetary reform

I have previously written about RBI in connection with capital controls, the lack of a countercyclical monetary policy, the issue of transparency, and the difficulties of trying to do monetary policy while not having a market for interest rates or currencies.

Today Ila Patnaik has an article in Indian Express titled How to solve the RBI problem about putting Indian monetary policy on a sound footing by having a small central bank which only sets the short rate, which is independent of the Ministry of Finance, but is accountable for hitting a publicly visible inflation target and is required to be transparent.

3 comments:

  1. I finally read Ila's utterly excellent recommendations on breaking up RBI activities. But she seems to indicate (in her other columns as well) her preference for inflation target. What's your take on fixed inflation target as a monetary policy, if you have any? From what little I know, I didn't think it worked very well in New Zealand.

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  2. Inflation targeting is in use in roughly 20 countries, not just NZ (which invented it). My sense is that it's worked pretty well. The promise of inflation targeting is that expectations are anchored, inflation becomes less persistent, GDP growth volatility goes down.

    There is a preliminary literature which finds some interesting results. I think the facts suggest that (a) inflation persistence does go down with inflation targeting and (b) that `inflation compensation', or the gap between the return on nominal bonds when compared with inflation indexed bonds, goes down under inflation targeting. The UK is a favourite natural experiment for these kinds of papers, because it has the rich array of financial markets that generate all kinds of nice data both before and after inflation targeting was introduced.

    Another strand of normative monetary economics is the link to the `Taylor principle'. Inflation targeting easily connects to having an inflation coefficient of more than 1, and thus having a stabilising monetary policy. (This is neither necessary nor sufficient, but there is a coherence between the Taylor principle and inflation targeting).

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