Editorial Simplified: RBI’s Independence | GS – III

Independent central banks are better at controlling inflation. Shielded from the pressures of day-to-day politics, they can take a longer term view and make unpopular decisions.

Relevance : GS Paper III (Indian Economy)


Introduction

A pushback is underway, globally, against the tenet of central bank independence.


Argument in favour of independence

Independent central banks are better at controlling inflation. Shielded from the pressures of day-to-day politics, they can take a longer term view and make unpopular decisions.


Argument against independence

Economies with independent central banks don’t always do better in financial crises. The reason is that, as central banks have turned to new tools such as bondbuying, they have taken on more of the roles (of) lawmakers and government spending.


The dilemma

  • The debate on central banks’ independence comes down to a larger dilemma in democracies. That is, how much to leave to dispassionate experts who can take cold, hard decisions, rather than to popularly elected governments that are susceptible to short term pressures?
  • Do governments take populist, economically unsound decisions? Of course, they do from time to time. But equally, are unaccountable, unelected technical experts infallible? Sadly, they are not. More on this below.

The recent global trends

  • The recent years have seen a pushback against central banks’ independence.
  • A major turning point was the global economic crisis of 2008. The US Federal Reserve was accused of having kept interest rates too low and causing the crisis.
  • Globally, though central banks’ formal operational independence is still rather new – for instance, the Bank of England only got it in 1997 – there are already reverses. In 2013 the Bank of Japan agreed to coordinate policy with the government, and other nations are trying to follow suit.
  • In recent years India’s RBI has been accused of repeatedly getting its inflation forecast wrong and keeping interest rates too high, thus starving a growing economy of much needed liquidity.

Are bureaucrat governors antithetical to RBI’s independence?

  • The assumption that former bureaucrats are sure to be pliant RBI governors is not borne out from experience, with both YV Reddy and D Subbarao having been widely respected.
  • In fact, Stiglitz went so far as to say that the last US recession might have been avoided if Reddy had been the Fed chairman.

Conclusion

RBI governor needs to find a balance between taking tough, unpopular decisions – with or without government backing – while also keeping an open mind towards urgent, short to medium term economic imperatives.


 

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