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.

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  1. I generally agree with the main point of your argument.

    However, off the top of my head, the INR has devalued by 50% of so since 2011. It will probably devalue more, I guess.

    That seems to be the most significant factor in terms of the Indian economy adjusting – or India’s policy easing.

    It’s also why the Indian stock market is holding up quite well, while the Chinese has been tanking since 2010 or so.

    Given that either the EM currencies (in India, Brazil) or the EM stock markets (China) have been in a bear market for years, I really wonder why people are talking about a repeat of the Asian crisis now – after such a long time lag since the downtrend began.

    Could it be that some market participants are a bit bored during the summer lull and need to bring some excitement into the markets because nothing much is happening? Volumes are very thin now, as you know. Sell side desks sit around and are sometimes desperate to generate some “new” ideas.

    Maybe I’m wrong. But I have this sneaking suspicion that something’s a bit strange about this sudden discovery out there that EM are in a bear market. They have been for some time now.

  1. The Danger of an All-Powerful central banks – against macroprudential policies | The Market Monetarist

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