## Sunday, April 22, 2007

### Learning how monetary policy ought to work

Financial Express has an editorial remarking on the letter that the Bank of England had to write to the Chancellor of the Exchequer since inflation crossed 3%, and ruminating on Indian monetary policy questions in this light. The letter is remarkably well written, and is well worth reading for all who are interested in monetary policy. It is free of central bank mumbo-jumbo; it is written as clearly as a `Frequently Asked Questions' on the net.

Why does the Bank of England eschew central bank mumbo jumbo while RBI is steeped in it? I think there are two forces at work. The first is the sheer need for transparency to make monetary policy effective: Bank of England lives within a full set of financial markets where monetary policy transmission critically relies on finance knowing the monetary policy rule. RBI's strategy is to stifle the financial markets, and in such a strategy, it is felt there is no need to communicate honestly with financial markets. But equally, I think the clarification of the objectives of the Bank of England was essential for them to graduate to such clear and logical speech. With RBI, the burden of multiple conflicting roles makes it difficult for the RBI to be clear about what it is trying to do and why. Transparency is then jettisoned because if the reader fully knew what was being done, that would expose the full scale of difficulties. Each episode of stress is dealt with by hiding problems under the carpet, and repeated episodes of stress generate an institutional bias in favour of opacity.

Please note: LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.