Reserve Bank of India and the Tinbergen rule: Please end the stop-go policies!

It is hard to keep track of the direction of monetary policy in India. This is from Bloomberg this morning:

Indian (SENSEX) stocks climbed for the first time in four days, led by the biggest rally in financial shares since 2009, after the central bank said it will buy government bonds to combat surging borrowing costs.

So now the Reserve Bank of India (RBI) is effectively doing quantitative easing. Meanwhile this is also from Bloomberg not long ago:

The Reserve Bank of India on July 22 made it mandatory for importers to set aside 20 percent for re-exports as jewelry. The measures to moderate demand boosted the premium that jewelers pay to importers to about $10 an ounce over the London spot price from as low as $4 a week earlier, according to the the All India Gems & Jewelry Trade Federation.

Hence, RBI stepped in to curb the buying of gold by Indians to stop the sell-off in the rupee. That of course was monetary tightening.

The truth is that RBI is trying to do everything at the same time—ease monetary policy to push down yields, tighten monetary policy to curb the sell-off in the rupee, while at the same time trying to curb inflation by tightening monetary policy and easing monetary policy to spur growth. Confused? Not as much as the RBI…

It is about time that somebody reminds the RBI about the Tinbergen Rule: For each and every policy target there must be at least one policy tool. If there are fewer tools than targets, then some policy goals will not be achieved.

The only thing RBI fundamentally can do is to control the money base to hit one nominal target. Therefore, it is also about time that RBI comes clean on this.

RBI can only hit one target (with one instrument). That target in my view should be a nominal gross domestic product (GDP) target, but the most important thing now is that RBI just announces one nominal target—be it an inflation target, a price level target or a nominal GDP target.

RBI should immediately end the attempts to distort financial prices—whether in the fixed income or the currency market. Leave it to the markets to determine the prices in the fixed income markets and the currency markets.

If RBI is concerned about the heightened volatility in the Indian financial markets it should at least stop creating volatility on its own. The best way of doing this of course is to announce a clear rule-based monetary policy.

There is only so much monetary policy can do. Monetary policy is extremely effective when it comes to hitting a nominal target, but monetary policy cannot do much about India’s other problems—for example the major public finance problems. The Indian government has to take care of that problem.

PS One can of course fear that RBI will not give up on trying to hit more than one target. Then it, however, will need more policy instruments. Normally this would be capital and currency controls. God forbid the RBI will venture down that road.

This post has also been publlished at livemint.com.

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The Second Asian Crisis? Feeling the impact of Chinese monetary tightening

This is from Bloomberg this morning:

Asian stocks fell for a fourth day after U.S. Treasury yields reached a two-year high. Currencies from Malaysia to Thailand declined amid an emerging market exodus that’s seen investors withdraw $8.4 billion from exchange-traded funds this year.

…Indonesia’s Jakarta Composite Index dropped 3 percent, taking a four-day rout beyond 10 percent…Malaysia’s ringgit decreased for a seventh day, and the Thai baht fell 0.8 percent.

…Asian economies are struggling to ignite growth.

…Five stocks fell for every three that gained on the Asia-Pacific index. Real estate and construction firms led declines in Jakarta where the benchmark index tumbled as much as 20 percent from a high in May.

China’s economy, No. 2 in the world, has been slowing for the past two quarters. Indonesian shares led declines in emerging Asian markets yesterday, sliding 5.6 percent, after data showed the current-account deficit widened to a record last quarter. A report this month also showed the economy grew less than 6 percent for the first time since 2010 in the second quarter.

…Foreigners sold a net $3 billion of Indian stocks and bonds in July amid the slowest growth in a decade in Asia’s third-largest economy, according to data compiled by Bloomberg. The rupee slid to a record low yesterday and 30-day volatility on the CNX Nifty Index touched the highest level since April 2012.

…Thailand’s SET Index dropped 3.3 percent yesterday, the most in two months, after a report showed the economy unexpectedly shrank in the second quarter, pushing the country into a recession. The government also cut its growth forecast.

It is hard to feel optimistic about growth in Asia when you read this kind of thing.

In the article the market turmoil is blamed in Fed “tapering”, but I would suggest that Chinese monetary tightening is at least as important. Hence, China is as I have argued earlier the monetary superpower of Asia and Chinese monetary tightening weigh heavily on the Emerging Asian currencies. If the “local” central banks try to fight the currency sell-off then they are automatically importing monetary tightening from China causing growth to slump. The slump in the local stock markets is an indication that this is in fact what is partly happening.

The good news is that we are in fact seeing currencies weaken across Asia – that is softening the blow from the “China shock” . The bad news is that Asian central banks in general has been fighting the currency sell-off by hiking interest rates, intervening in the FX markets and by introducing all kinds of draconian currency controls. All that is likely hit growth across the region. And yes, I am quite nervous about new cases of monetary policy failure, where local policy makers in their attempts to curb the currency sell-off end up doing more bad than good. Just take a look at stop-go policies of Bank Indonesia and the Reserve Bank of India over the past two months.

The best way to shield the Asian economies from the negative impact of Chinese monetary tightening and fed tapering is to let currencies float completely freely and to the extent necessary letting the currencies weakening. Trying to fight the currency sell-off with monetary tightening is the recipe for setting of the Second Asian Crisis. As long as the impact of the Chinese monetary tightening continues Asian policy makers have the choice between weaker currencies or lower growth.  You cannot have both in the present situation.

Airport musings on India, Danish efficiency and Larry Summers

I am writing this while I am sitting in London’s Heathrow Airport (Terminal 5) after having spent a couple of days in London.

To be quite frank I think I have been suffering from a bit of writer’s block in the past couple of weeks – maybe because I have been too busy with other things, but also because I have been a bit uncertain what stories I really wanted to tell. I could of course blame Paul Krugman – after all his writings on Milton Friedman greatly upset me and I wanted to respond to Krugman’s posts on Friedman, but on the other hand I didn’t really want Krugman to dictate what I was going to blog about. So enough said about Krugman.

So now I am trying to get over the writer’s block with another round of musings.

The most interesting story – India. Unfortunately it is not positive

Since May the Indian rupee has more or less been in a free fall to the great concern of Indian policy makers who are trying hard to curb the sell-off. Anybody who has read and understood Milton Friedman’s classic article “The Case for Flexible Exchange Rates” will be able to realize that the Reserve Bank of India (RBI) is making a serious policy mistake when it is trying to curb the weakening of the rupee.

The sell-off in the rupee has likely been triggered by market fears of Fed tapering, general Emerging Markets gloom and spill-over from the Chinese growth slowdown. However, it is also clear that India is suffering from serious structural problems which have resulted in a double deficit – sizable current account and public finance deficits.

All this easily explains and justifies the weakening of the rupee. Hence, the sell-off is a natural reaction to external shocks and imbalances in the Indian economy. The Indian authorities should therefore fundamentally welcome the drop in the rupee as a natural adjustment. An adjustment that will be a lot smoother than if India had had a fixed exchange rate regime.

However, the RBI’s insistence on trying to curb the sell-off in the rupee is fundamentally an abrupt monetary policy tightening and the likely result is that Indian growth is going to take a beating.

One can of course argue that the RBI long ago should have moved to tighten monetary policy – NGDP growth clearly was excessive in 2008-10. However, the fundamental problem is the RBI’s lack of commitment to a clear and transparent monetary policy rule. The RBI’s continued extremely discretionary stop-go policies are a serious problem in terms of both macroeconomic and financial stability.

In my view the RBI should implement an NGDP targeting regime targeting 7 or 8% NGDP growth going forward (see more on that suggestion here). That would be a “tighter” monetary policy than what we have seen in recent years, but it would likely be “expansionary” in the sense that it would provide a lot more stability for the Indian economy, which likely would help boost long-term real GDP growth. Furthermore, a clear and transparent monetary policy would provide the necessary nominal stability for the Indian government to start serious structural reforms to reduce India’s large public budget deficit and to boost long-term trend growth.

Ashok Rao has a couple of very good posts on India. Ashok provides some justification for the RBI’s attempts to curb the sell-off in the rupee and he also provides some arguments why we should not become too negative on the Indian economy. I disagree with some of what Ashok is saying, but he has good arguments. Take a look for yourself (here and here).

Denmark is the most efficient economy in the world (at least in terms of airport security)

Thursday morning when I was flying to London from Copenhagen I noticed a billboard saying that Copenhagen Airport has been voted the most efficient airport in the world when it comes to airport security by something called Skytrax. I have earlier argued that efficiency in airport security is a good indicator of the overall level of regulation/efficiency in an economy.

So I guess if Skytrax is right then there might be some reason to argue that Denmark indeed is the most efficient/competitive economy in the world or at least the least regulated economy in the world. If we look at different competitive and regulation indicators Denmark actually is on the very top in the world – whether you look at the Heritage Foundation’s Economic Freedom Index, the World’s Ease of Doing Business index or the World Economic Forum’s Global Competitiveness Report.

I haven’t had time to look more at the Skytrax data, but I am pretty convinced that the Skytrax rating of airport security efficiency will be highly correlated with other measures of economic efficiency/competitiveness. Maybe, maybe one of these days I will write more on this…

Summers is not more hawkish than Yellen, but he will be massively more partisan

I have been trying to write a blog post on Summers vs Yellen, but now I will instead just state some of the conclusions here.

It is normally assumed that Larry Summers will be a more hawkish Fed chairman than Janet Yellen because he dislikes quantitative easing (as many other paleo-Keynesians). However, I think it is important to note that Summers’ preferences in terms of unemployment versus inflation certainly are not hawkish. Rather the opposite. He just thinks that fiscal policy rather than monetary policy should be used to boost aggregate demand.

Therefore, in a world where the Fed is moving toward “tapering” and in a couple of years rate hikes there is likely not a big difference between Yellen and Summers. It is only if additional “stimulus” is needed – due to for example a new negative shock – that Summers will be more hawkish than Yellen.

Furthermore, Summers is a Democrat and part of the Clinton “family”. Therefore I am fairly convinced that he will do anything to help Hillary Clinton get elected US president in 2016. Yellen on the other hand is much less likely to act as a partisan Fed chairwoman.

Now some might say that Market Monetarists have been screaming about the need for monetary easing for years so we should be happy if Summers becomes Fed chairman and actually steps up monetary easing toward the 2016 presidential elections.

That, however, would completely miss the point Market Monetarists have been making. We want a clear monetary policy rule. We don’t care about discussing monetary policy in terms of hawks and doves. We need the Fed to follow a monetary policy rule. Both Yellen and Summers are likely to be tempted to continue the Fed’s unfortunate discretionary policies.

Summers famously was on the “committee to save the world” when he with Rubin and Greenspan “saved” the world from disaster during the Asian crisis in 1997. I am extremely critical about about Summers’ abilities as a firefighter. In fact I am extremely critical about the very concept that central bankers should act as firefighters.

Central bankers should instead stop starting fires. However, I am afraid that 2014 might very well be the year where Chairman Summers will be trying to save the world from the Second Asian Crisis. Yes, I have some very deep concerns about how things will play out in Asia – with both China and India likely to make new serious policy mistakes.

PS I most of this article was written in Heathrow airport on Friday. I am now happily back home in Denmark.

 

Too easy AND too tight – the RBI’s counterproductive stop-go policies

Only a couple of days ago I was complaining that the Turkish (and the Polish) central bank(s) have been intervening in the currency markets. My complains of the Turkish central bank’s fear-of-floating and what seemed to be politically motivated monetary operations were then followed by the Brazilian central bank that hiked interest rates – officially to curb inflationary pressures, but what to me very much looked like an effort to prop up the Brazilian real.

It indeed seems like there is a pattern emerging in particularly in Emerging Markets. The latest central bank to jump on the FX intervention bandwagon is the Reserve Bank of India (RBI). This is from Reuters:

“The Reserve Bank of India (RBI) announced measures late on Monday to curb the rupee’s decline by tightening liquidity and making it costlier for banks to access funds from the central bank.

The RBI raised the Marginal Standing Facility (MSF) rate and Bank Rate each by 200 basis points to 10.25 percent, capped the amount up to which banks can borrow or lend under its daily liquidity window and announced a sale of government securities through an open market operation.

The RBI said total funds available under its repo window will be capped at 1 percent of banks’ deposits – roughly 750 billion rupees – from Wednesday. It announced a 120 billion rupee sale of government bonds for Thursday.

The central bank does not set a target for the rupee, which hit a record low of 61.21 to the dollar last week, but it does take measures to manage volatility”

It is very hard to be impressed by the RBI’s de facto currency targeting as there is hardly any economic arguments for  the RBI’s actions, but we can safely conclude whatever motivated the RBI have just implemented significant monetary tightening.

Too easy AND too tight – it’s called stop-go monetary policy

I have earlier argued that there might be arguments for tightening monetary policy in India. Hence, since 2009 nominal GDP has risen much sharper than the earlier NGDP-trend of around 12% NGDP growth.  The graph below illustrates this.

NGDP India July 2013Furthermore, there is there is nothing “optimal” about a 12% NGDP growth path. In fact I believe that the RBI if anything rather should target an NGDP growth path around 7-8% (as I have argued earlier).

The problem with the RBI’s recent actions is not necessarily the decision to tighten monetary policy per se, but rather the in fashion it is done.

The RBI’s decision has clearly not been based on a transparent and rule based monetary framework.

Hence, after years of high NGDP growth and high inflation the RBI suddenly slams the brakes. And mind you not to hit an NGDP level target or an inflation target for that matter, but to “stabilize” the currency.

The result of this currency “stabilization” might be that the RBI will be able to curb the sell-off in the rupee (I doubt it), but we can be pretty sure that the cost of this “operation” will likely be a fairly sharp slowdown in Indian real (and nominal) GDP growth. You have to choose – either you have a “stable” currency or stable macroeconomic conditions. I fear that the RBI has just sacrificed macroeconomic stability in a ill-fated attempt to stabilize the currency – at least if the RBI insist to continue the policy of FX intervention.

In a sense the RBI has been pursuing both too easy monetary policies – too high NGDP growth and inflation – and at the same time too tight monetary policy in the sense of an abrupt monetary contraction to prop up the rupee. This is the core of the problem – the RBI’s counterproductive stop-go policies.

The way forward – a completely freely floating rupee and 8% NGDP target 

In my view the RBI urgently needs give up its policy of fiddling with the currency and instead let the rupee float completely freely and instead announce an target on the nominal GDP level.

In my view the historical trend of 12% NGDP growth is too high and a lower NGDP growth target of 8% seems to be more appropriate. The RBI should hence announce that it gradually will slow NGDP growth to 8% over a five period. It is important that this should be a level target. Hence, if growth is faster than 11% in 2014 then it is important that NGDP growth will have to be even slower in the next four years. That is exactly the idea with a level target – you should not allow bygones-to-be-bygones. After 2018 the RBI will keep NGDP on 8% growth path.

Such a policy will ensure a lot more nominal stability than historically has been the case and therefore also very likely significantly increase macroeconomic stability.

Furthermore, a side effect will that the rupee likely will be more stable and predictable than under the present stop-go regime as FX volatility to a very large extent tend to be a result of monetary disorder.

A serious need for kick-starting economic reforms

There is no doubt that India seriously needs nominal stability, but there also is also a massive need for structural reforms in India. I think this story (quoted from Bloomberg) tells you everything you need to know about the extent of harmful and unnecessary government intervention in the Indian economy:

“For more than 100 years across the 19th and 20th centuries, its gnomic messages, worked into Morse code and out into language again, then delivered by postmen, connected human beings in faraway places. It announced births, marriages and deaths; called soldiers home from war or announced their demises to their families (or changed the course of the war itself); confirmed job offers or remittances to anxious and impatient souls. The voice of history whenever it was in haste, it was stoic by nature — concealing waves of emotion under its impassive, attenuated syntax — and easily available to rich and poor, in city and village.

In India, it was installed by the British as a way of administratively and militarily linking up the vast reaches of the subcontinent. But it became one of the engines of the freedom movement, a way for the Indian migrant to keep up a tenuous link to the world he had left far behind. The Indian word for it was “taar,” or wire, invoking an image more concrete than the English “telegraph.” (The “wire,” in English, was claimed by news media services.) Long after the rest of the world had moved on to more advanced technologies, the humble telegraph continued to enjoy great currency in India, before the onset of the digital revolution began to chip away at its hegemony. But the end has been in sight for some years now.

With the explosion of the mobile-phone revolution in the last decade (described recently in “The Great Indian Phone Book“), the telegraph service began for the first time to appear anachronistic. Text messages sent from mobile phones began to make the taar service seem quaint, even to rural users. This weekend, Bharat Sanchar Nigam Ltd, the state-run company that runs the system, is finally set to wind down its telegraph service for good, just as Western Union decided in 2006 that it was over for its telegrams in the U.S. Almost 16 decades after a member of the Indian public sent a telegram for the first time in 1855, the telegram will finally give up the ghost in one of its last surviving redoubts.

The Indian telegraph service still processes about 5,000 telegrams each day (most of them government notifications).

It is truly bizarre that a developing country like India until this day has continued to have a government run telegraph company, but I think it tells you a lot about how extreme the level of government intervention in the Indian economy still is.

In the 1990s growth was kick-started by a number of supply side reforms. However, over the past decade speed of reforms have been much more slower and in some area reforms have even been scaled back.

In this regard it should be noted that inflation has been stubbornly high – around 7-8% (GDP deflator) – since 2009. But at the same nominal GDP growth has slowed. This to me is an indication that while monetary policy has indeed become tighter India has also at the same time seen a deterioration of supply side conditions. The result has been a fairly sharp slowdown in real GDP growth in the same period.

I think it is quite unclear what is potential real GDP growth in India, but I think it likely is closer to 5-6% than to 8-10%. This would seems to be a quite low trend-growth given the low level of GDP/capita in India and India’s trend-growth seems to be somewhat lower than that of China.

Concluding, while a monetary regime change certainly is needed in India serious structural reforms are certainly also needed. The best place to start would be to get rid of India’s insanely high trade tariffs and generally opening up the economy significantly.

Update: s shorter edition of this blog post has also been published at financeasia.com. See here.

In Indian inflation is always and everywhere a rainy phenomenon

Take a look at this “Phillips” curve for India (its not really a real Phillips curve – as it is the relationship between annual real GDP growth and inflation):

Phiillips curve India Do you notice something?

Yes you are right – the slope of the Phillips curve is wrong. Normally one would expect that there was a positive relationship between real GDP growth and inflation, but for India the opposite seems to be the case. Higher inflation is associated with lower GDP growth.

The reason for this obviously is that supply shocks is the dominant factor behind variations in Indian inflation. That should not be a surprise as nearly 50% of the consumption basket is food.

Rain as a supply shock

A closer scrutiny of the Indian inflation data will actually show that the swings in Indian inflation primarily is a rainy phenomenon. Hence, the Indian monsoon and the amount of rainfall greatly influences the food prices and as a result short-term swings in inflation is primarily due to supply shocks in the form of more or less rainfall.

Obviously if the Reserve Bank of India (RBI) was following a strict ECB style inflation target then monetary policy would be strongly pro-cyclical in India as negative supply shocks would push up inflation and down real GDP growth and that would trigger a tightening of monetary policy. This would obviously be an insanely bad way of conducting monetary policy and the RBI luckily realises this.

The RBI therefore focuses on wholesale prices (WPI) rather than CPI in the conduct of monetary policy and that to some extent reduces the problem. The RBI further try to correct the inflation data for supply shocks to look at “core” measures of inflation where food and energy prices are excluded from the inflation data.

However, the problem with use “core” inflation that it is in no way given that changes in food prices is driven by supply factors – even though it often is. Hence, demand side inflation might very well push up domestic food prices as well. Hence, it is therefore very hard to adjust inflation data for supply shocks. That said it is pretty hard to say that the RBI has followed any consistent monetary policy target in recent years and inflation has clearly been drifting upwards – and food prices can likely not explain the uptrend in inflation.

On the other hand NGDP targeting provides the perfect adjustment for supply shocks  and it would therefore be much better for the RBI to implement an NGDP target rather than  a variation of inflation targeting. Unfortunately at the present the RBI don’t really officially target anything and monetary policy can hardly be said to be rule based. As I stressed in my earlier post on Indian monetary policy the RBI needs to move away from the present ad hoc’ism and introduce a rule based monetary policy.

PS Monetary policy is certainly not India’s only economic problem – and not even the most important economic problem. I my view India’s primary economic problem is excessive interventionism in the economy, which greatly reduces the growth potential of the economy.

PPS see also this fairly new IMF Working Paper on monetary policy rules. The conclusions are quite supportive of NGDP targeting.

PPPS The link between rain, inflation and monetary policy in India is being complicated further by the fiscal response in the form of food and agricultural subsidies in India, but that is a very long story to tell…

India needs Market Monetarism

There is no doubt that the popularity of NGDP level targeting is increasing and with that partly also the popularity of Market Monetarism. However, as the popularity is growing so is the misunderstandings about both.

First, I would stress that while Market Monetarists advocate NGDP level targeting the two things should not be seen as the same thing. NGDP level targeting is a monetary policy advocated by Market Monetarists, but also by others – such as certain New Keynesian economists such as Christina Romer and Michael Woodford. Market Monetarism on the other is an economic school – or said in another way – it is a way to think about monetary policy and monetary theory.

Today I came across an interesting article by Niranjan Rajadhyaksha with the intriguing headline “India does not need market monetarism” that illustrates some of the misunderstandings about Market Monetarism and NGDP level targeting.

Here is from the article:

The Bank of Japan said on Tuesday that it would try to push up inflation as part of a new strategy to stimulate the economy. Such an attempt would have been met with gasps of disbelief a few years ago, when low inflation was the central quest of monetary policy. A higher inflation target is now becoming an important part of the ongoing policy debate, at least in the developed countries that are still struggling to recover from the economic effects of the financial crisis.

What has just happened in Japan is another victory for a group of economists called market monetarists, who have argued over several years that policymakers should target the nominal gross domestic product (NGDP), which is a combination of real output and inflation. Targeting nominal GDP can be contrasted with what the two main schools of macroeconomics suggest: the traditional monetarists look at money supply and the new Keynesians look at interest rate.

Well, yes it is a victory in the sense that the Bank of Japan now finally is clear on what the central bank is targeting (2% inflation). However, Market Monetarists would certainly have preferred an NGDP level target to an inflation target.

Niranjan continues:

The market monetarists once tried to be heard from the sidelines. They have since gained popularity and are now an important voice in the corridors of power. The US Fed has not yet embraced nominal GDP targeting, but there are signs that market monetarism is getting heard in that institution. Chicago Federal Reserve president Charles Evans is one important convert.

The new Bank of England governor Mark Carney is known to be sympathetic to the market monetarist cause. Japanese Prime Minister Shinzo Abe has also been talking about pushing up Japanese nominal GDP, and his influence in evident in the new Bank of Japan policy statement. All implicitly believe that a higher inflation target will goad rational consumers to spend before prices go up, thus boosting economic activity

So far so good, but again an higher inflation target in Japan is not an NGDP level target, but certainly better than the non-target the BoJ has effectively been practicing for the past 15 years.

But then it goes wrong for Niranjan:

The situation in India is very different. It is unwise to use higher inflation as an important part of any strategy for economic recovery, though there has been loose talk of allowing the Reserve Bank of India to let its unofficial inflation target rise. India already suffers from structurally high inflation. Inflation expectations seem to have drifted up in recent years. These will damage the economy in the long run.

Yet the Indian government has been following a perverse variant of nominal GDP targeting. High inflation has led to robust nominal GDP growth despite the slowdown in real output, which in turn has ensured that the burden of public debt in India has not expanded despite large fiscal deficits. Look at the numbers. Nominal growth in fiscal 2011 was 17.5%, the highest in 20 years. Nominal GDP growth has been growing faster in the four years after the global financial crisis than in the four years that preceded it. In other words, the Indian government has been inflating away its old debts, most of which are held by Indian households through the banking system.

Market monetarism and nominal GDP targeting may make sense in economies that have persistent negative output gaps and interest rates at the lower bound. India is in a different situation. It needs lower inflation to get its economy back on track.

Niranjan seems to equate Market Monetarism and NGDP level targeting with a desire for higher inflation. The fact is, however, that Market Monetarists don’t advocate higher inflation. We advocate a higher level of NGDP for countries such as the US or the euro zone where the level of NGDP is well below the pre-crisis trend level. We don’t concern ourselves with the “split” between real GDP and the price level – the only thing we concern ourselves with is the NGDP level.

Furthermore and much more importantly we are advocating a rule based monetary policy – so we are not advocating the central bank should jump from one stance of policy to another in a discretionary fashion.

In addition Market Monetarists are not “hawks” or “doves”. We are doves when the actual level of NGDP is below the targeted level of NGDP and hawks when the opposite is the case. So yes, for the US or the euro zone we might sound as “doves” in the sense that we (the Market Monetarist bloggers) have been advocating easier monetary policy to bring back NGDP “on track”. What we are arguing is not “stimulus” in a discretionary fashion, but rather a return to a rule based monetary policy.

But what about India?

From 2000 and until the outbreak of the Great Recession in 2008 Indian NGDP grew by around 12% a year. There is is obviously nothing “optimal” about that number, but lets as a starting point see that as our benchmark.

The graph below shows the actual level of Indian NGDP and a 12% growth path for NGDP starting in 2000.

NGDP India
The graph is pretty clear – actually NGDP has been running well above the 12% path in recent years. So if the Reserve Bank of India (RBI) had targeted a 12% NGDP level path then it would certainly had kept a tighter monetary stance in recent years than what actually have been the case.

Hence, the Market Monetarist advise to the RBI would be to tighten monetary policy – rather than the opposite.This illustrates that Market Monetarism is not about being “hawkish” or “dovish”. It is about advocating a rule based monetary policy and at the moment a 12% NGDP level target for India would mean that the RBI should tighten – rather than ease . monetary policy.

Therefore, Niranjan is certainly right when he is arguing that India does not need monetary easing, but that is exactly the conclusion you would reach as a Market Monetarist!

In fact I think that most Market Monetarists would think that a 12% NGDP level target for India is too high and I would personally think a long-term NGDP level target path should be around 7-8% rather than 12%.

Concluding, if the RBI had an NGDP targeting rule it would have kept monetary policy significantly tighter in recent years. The actual conduct of monetary policy in India has nothing to do with Market Monetarism. The only difference between the ECB and the RBI is that the ECB failed on the “tight side” while RBI failed on the “easy side”.

So Niranjan, you are right to worry about the RBI’s overly easy monetary policy, but don’t blame Market Monetarism. You should rather endorse it. We are with you – the RBI has failed exactly because it has not conducted monetary policy within a rule based framework and the RBI should tighten monetary policy sooner than later. And of course introduce an NGDP targeting rule asap.

—-

PS a major advantage of NGDP level targeting compared to inflation targeting is that NGDP level targeting would “ignore” supply shocks. This is very important for an Emerging Market economy like India where headline inflation often is driven by supply shocks in the form of changes in food and energy prices.

Hence, it is well-known that most of the short-term variation in Indian inflation is driven by food prices. A strict inflation targeting central bank would react to higher inflation by tightening monetary policy – this is of course the ECB style inflation targeting regime. Contrary to this an NGDP level targeting central bank would not react to supply shock and instead just keep NGDP on track.

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