The government has just announced a change of guard at the Reserve Bank of India (RBI) with Urjit Patel going to take over as the new governor. Some of the circumstances leading up to this change have been too unsavoury, and are not the concern of this essay. Under the circumstances, the current governor, Raghuram Rajan, a noted economist with a fair degree of academic standing, did the only thing any self-respecting individual was supposed to do, which is to not seek a second term. This is reassuring in a country where public functionaries often cling to their posts in the face of obvious contradictions in the policies they have vigorously espoused and then having to unceremoniously backtrack without a trace of diffidence and holding on to their positions till their last day on the job.
The discerning public is aware of many such recent, and possibly some long past, episodes but we do not wish to dwell on these. Our concern here is to focus on what ought to be the underlying principles informing the relationship between the central bank and the central government of India. This has been a matter of no small concern to economists and policymakers at least over the past half century, much of the discussion emanating from the Anglo-American world, but plenty too in our own setting, especially after economic reforms were initiated in India a quarter century back.
This issue has also, suddenly, become topical because there is yet another recent RBI governor, Duvvuri Subbarao, who has just come out with some revelatory tales while he was in the portals of the venerable RBI. The sum and substance of this account is to show how he steered the RBI through five turbulent years even in the face of the uneasy relationship with the two finance ministers, Chidambaram and Pranab Mukherjee, he served under. Subbarao writes: “This skirmish with Chidambaram, who I believed pushed my candidature for the governor’s job, so early in my tenure, upset me a lot. Little did I know that this set the tone for what would be an uneasy relationship between us in the last year of my term.”
Far too many public functionaries in recent years have come out with tell all books which paint themselves variously as angelic, misunderstood, or honourable beings, and it would take some time before a dispassionate assessment of the latest book is made. But the book does raise some very important issues pertaining to the relative turf areas of the RBI and the ministry of finance.
The RBI commenced operation on April 1, 1935. It is India’s central bank which controls the monetary policy of the country. It is perhaps not commonly known that among the first to make a clear case for a central bank for India was none other than John Maynard Keynes, who wrote extensively on central banking in his “Indian Currency and Finance” as early as in 1913. He elaborated these ideas further in the course of his work as a member or as an expert witness for successive Indian Currency Commissions and committees (1913-26), and also in the second volume of his ‘Treatise on Money’ (1930).
Keynes never visited India. His first job as a civil servant in 1906 was in the India Office, where he spent most of his time working on probability theory. He quit the job in two years’ time to return to Cambridge and it was in 1913, at age 30, when he wrote his first significant tract in economics: “Indian Currency and Finance”. Keynes’s intellectual interest in matters concerning central banking derived from his interest in devising an appropriate institutional framework for the effective and efficient operation of the monetary system in India.
Long before the universal acceptance of the case for establishing central banks after the Brussels Financial Conference in 1920, Keynes had presented a detailed operational blueprint for establishing a central bank in India, even though the country was still a British dependency. Keynes was always clear about both a regulatory as well as a developmental role for the Indian central bank. It is important to emphasise that Keynes was far from advocating any simplistic notion of “inflation targeting”, which many latter-day monetarists choose to think of as their chief priority. Indeed the principal Keynesian focus was on maintaining full employment and output, and, as is well known, in his essential formulation in his pathbreaking tract General Theory (1936), prices are fixed.
A very important question pertains to the issue of the relative roles of fiscal and monetary policies in steering any economy, developed or developing. In some of the extreme forms of monetarism, price stability is regarded to be the only abiding concern of monetary policy, and hence strictly within the turf of the central bank. It is well known that in most settings output and employment growth – the usual concerns of any finance minister in a developing country like India – would typically involve tailoring tax and expenditure policies to raise aggregate demand that would generally also push up prices. Mature macroeconomic management has to carefully balance these two opposing tendencies. In a country with massive open unemployment it would be a travesty of responsible public policy to be only concerned with inflation targeting. In other words, a moderate inflation rate, say, 3-4%, may have to be accepted as a price to pay for a moderately high growth rate in the range of, say, 7-8%. In any democratic country, the government must ultimately be answerable to the general public. There is nothing in the Keynesian formulation that suggests that inflation and interest rates should only be within the domain of the central bank. These are very much matters of real concern for any responsible government as well.
Pulin B Nayak retired as professor of economics from the Delhi School of Economics
The views expressed are personal