The minutes of the meeting of the Reserve Bank of India’s Monetary Policy Committee used to be largely repetitive of policy details – going into the details of analysis and decisions, but this changed in October 2020 when the MPC was introduced to include new faces Was reorganized.
Since then, extensive issues have been discussed in the minutes. One such discussion is the efficacy of so-called forward guidance. The MPC guides the markets with its policy stance for a fixed period of time to indicate its possible action. These are important for the markets but not all members are in favor of these time-based guidelines.
For the second time, Jayant Verma, an MPC member, a professor of finance and accounting at the Indian Institute of Management (IIM), Ahmedabad, has highlighted the problem with the failure of further guidance from the RBI. In the latest MPC policy minutes he has to say:
The major motivation for further guidance was to reduce long-term yields against the backdrop of an excessive yield yield curve. Unfortunately, further guidance has failed to level the yield curve and I now see little merit in keeping up with it. As the popular quote (often misinterpreted Albert Einstein) says: Insanity is repeatedly doing the same thing and expecting different results. A leveling of the yield curve remains an important goal but, I think it should use other means that are primarily located outside the remit of the MPC.
Varma goes on to say:
Another reason is that time-based forward guidance is no longer appropriate. The experience of the past several months suggests that in the aftermath of the epidemic, forecasting has become more difficult. It is clear that some economic and statistical relations have broken down in the current paranormal environment. As a result, model risk has now become an important issue as both are shown in large real forecast errors and the spread of forecasts from different models. Model risk presents a much less problematic problem than the well-defined statistical prediction of any single model. In this situation, it seems to me that it is not prudent to reveal excessive confidence in forecasts. Instead, MPCs must have the agility and flexibility to respond quickly and adequately that can bring new data into the future. Time-based guidance is inconsistent with this imperative.
This is not the first time Verma is raising these points. Soon after his appointment, he voiced his disagreement over the choice of MPC words used in his further guidance.
The guidance in the October policy stated this: “The MPC also decided to continue with a minimal adjustment stance during the current fiscal year and into the next financial year – to revive growth on a sustainable basis and mitigate the impact COVID-19 on the economy, while ensuring that inflation remains within the target going forward. “
Verma said that the date-based forward decision is not a decision but an expectation. In a world full of unpleasant surprises, MPCs have to be data-driven.
“I say strongly about the view that the MPC hurts its credibility when it uses words that do not imply its true meaning. Therefore, when I offered date-based further guidance in the MPC’s proposal When spoken, he disagreed with the choice of the word ‘sure’. Many experts agree with him.
“I am firmly of the view that the MPC risks damage to its credibility when it uses words that do not accurately reflect what it means. I therefore disagree with the choice of the word ‘decided’ when it comes to the date based forward guidance in the MPC resolution.”
If inflation continues to rise and growth is faster than expected, how will the MPC remain “stable”? What if high inflation forces the panel to raise the rate? Can it remain in an adjustment mode? Therefore, maintaining a harmonious stance is more of an expectation than a decision.
The basic point on both occasions — the inability of forward guidance — is discussed in the MPC by none other than Ashima Goyal, who stated in MPC’s latest meeting minutes that she would support a move to time-based data-based guidance. is. Both Verma and Goyal have a point. If the October guidance was intended to level the yield curve, this data suggests.
Secondly, outbreaks of coronaviruses have made economic data unpredictable. Not all attempts by RBI to hold yields for long have been successful. Despite the massive liquidity push, retail inflation is consistently high. In this context, should the MPC continue with its further guidance, or simply, as Verma suggests, with whatever new data it brings, has the agility and flexibility to respond rapidly and adequately? This issue certainly leads to a wider debate.