India started to loosen monetary policy again last week. Many welcomed the move, but some of the strongest advocates of unorthodox monetary policy are asking if the Reserve Bank of India might be going in the wrong direction.
On January 29, the central bank cut its policy rate by 25bp to 7.75% and reduced banks’ reserve requirements by the same amount, and it is expected to cut rates by a further 50bp this year.
Duvvuri Subbarao, head of the Reserve Bank of India, explained in his monetary policy review that the cuts would have three effects:
- investment will be encouraged;
- medium-term inflation expectations will remain anchored on the basis of a credible commitment to low and stable inflation; and
- liquidity conditions will improve.
Analysts broadly agreed with the central bank’s commitment to stimulate demand.
“RBI delivered a very balanced policy,” said Indranil Pan, chief economist at Kotak Mahindra. “There is a clear acknowledgement from the RBI that demand-side activity has remained low, growth has slowed below trend, probably needing the RBI to complement the reform measures recently taken by the government.”
This has been a common prescription in countries around the world, championed by monetary policy specialists who would like central banks to adopt a rules-based approach to targeting a certain level of nominal growth (real growth plus inflation).
In the US and the eurozone, this has led to calls for looser policy to stimulate nominal growth back to its historical level, which in turn has led some commentators in India to accuse the RBI of recklessly experimenting with so-called market monetarism — while others have praised it for being so bold.
The market monetarists themselves take a different view. “What we are arguing is not stimulus in a discretionary fashion, but rather a return to a rule-based monetary policy,” writes Lars Christensen, an economist at Danske Bank, on his blog marketmonetarism.com. “We are doves when the actual level of NGDP [nominal gross domestic product] is below the targeted level of NGDP, and hawks when the opposite is the case.”
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Looking at India’s NGDP, Christensen disagrees that growth has slowed beyond trend. From 2000 until the financial crisis in 2008, nominal growth came in at around 12%. “There is obviously nothing optimal about that number,” Christensen concedes, but even if that high benchmark is used, India’s current nominal growth is still above the 12% trend line.
“If the RBI had targeted a 12% NGDP level path then it would certainly have kept a tighter monetary stance in recent years than what actually has been the case,” Christensen says. “Hence, the market monetarist advice to the RBI would be to tighten monetary policy, rather than the opposite.”
India’s monetary policy is obviously not rule-based, but nor is it clear what the goal of the current easing is, beyond the bullet points above. If 14% nominal growth is not enough, how much is the right amount?
And to put that figure into context, Shinzo Abe would be delighted if his central bank could deliver just 3% nominal growth — and his critics are still complaining about the threat of inflation.
It seems unlikely that a policy of monetary easing is the right response for both countries, given the divergence in growth rates. And stock markets seem to agree. While investors have driven Japanese stocks higher in response to so-called Abenomics, India’s benchmark indexes have been falling for the past week, since Subbarao announced the rate cut.
Instead of the discipline of rule-based policy that Christensen would like to see, India seems to be indulging in a kind of me-too monetarism that may be overly loose. It will be interesting to watch how RBI policy evolves during the course of the year.
In the meantime, Christensen is promising to write more about Indian monetary policy — and that is a good thing. In the competition for ideas, alternative viewpoints are always welcome.
