Towards a better framework
My column last month on inflation and monetary policy provoked more response than usual, no doubt because of the heatedness of the debate, rather than any one thing I wrote. With some of the heat having subsided, this is a good time to revisit some of the issues. This is important since the long run goal of efficient monetary management remains, in my view, unrealised.
One indicator of sub-optimality is the range of opinions that were expressed over the past few weeks, on the conduct of Indian monetary policy. Some divergence of views can be expected based on different interests, but there was even disagreement on the basic facts of how much monetary tightening had occurred, let alone what was optimal. One conclusion I would draw from the past few weeks is the need for greater transparency and predictability of monetary policy. Predictability includes timing, but also can have implications for the range of instruments that the RBI uses. A more parsimonious use of instruments could promote simplicity, and hence the predictability of what any policy moves would accomplish.
Last month, I raised the idea of using the Taylor rule framework to assess the RBIs monetary policy stance. One former policy advisor suggested to me that I was using the term inflation targeting too narrowly, and that a high enough inflation coefficient in the Taylor rule would constitute inflation targeting. The issue remains as to whether the RBIs record fits the bill. I was pointed to the work of Vineet Virmani, of IIM-Ahmedabad, who estimates monetary policy rules for India for the period 1992-2001. A striking feature of Virmanis results is that the estimated rule is extremely sensitive to the inflation measure used. Using the headline measure of inflation, the WPI suggests that the RBIs rule (as implied by the data) has been destabilising, while an alternative (technically, a trimmed mean) indicates a rule with much better inflation-fighting properties (inflation-term coefficients of 1.6 to 2, versus 1.5 in Taylors original rule). Clearly, there is work to be done here in deciding what to measure and target. Virmani also allows for gradual adjustment of the interest rate, and suggests that the RBIs behaviour fits a different McCallum rule, in which nominal income is targeted.
More : inancialexpress.com
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