In professions in which perceptions matter, real skills are not valued much. But, no amount of rationalization can change the fact that real skills do matter. In economics, theoretical competence matters. Intelligence and rationality matters. Raghuram Rajan is supposed to take charge as the Reserve Bank Of India governor today. On Twitter, I see many people who question his citizenship and lack of central banking experience. But, Raghuram Rajan is an extremely competent economist. In India, this is not the norm. Ben Bernanke, the current chairman of the Federal Reserve is a talented American economist who understands the importance of inflation targeting. Perhaps it is true that Bernanke and Greenspan did not live up to their potential. But, the first essay on monetary economics many Econ nerds read when they were teens was the previous Fed Chairman Alan Greenspan’s “Gold and Economic Freedom”, because it was published in Ayn Rand’s non-fiction collection. Almost everything that is being written on inflation in the mainstream media is nonsense, but this paper of Raghuram Rajan and Eswar Prasad is brilliant.
If India already has an implicit and overriding inflation objective, why not formally make it the RBI’s focus? Ah, commentators argue, that would prevent it from intervening in the exchange rate when the inflation objective is being met. Precisely! Not only would the single objective allow the RBI to guide expectations better, we have also argued at length why exchange rate intervention is not effective in the medium term. Our critics think it is.
India is not unique in facing supply shocks. Indeed, the recent rise in commodities prices, especially oil, has been unprecedented. Despite this, inflation across the world is still averaging in the single digits, unlike in the 1970s. The reason is that central banks across the world have acquired credibility that they will fight spillover effects, and prevent generalized inflation. Maybe our politicians have kept India’s inflation low through extremely short-term and distortionary policies, but it is not that we are unique in the world. Many others have done so with far fewer distortions. Perhaps there is something to be learnt?
What about the argument that India is unique in that our politicians will always intervene? The “India is unique” argument is intellectually bankrupt. It is the natural response whenever anything is proposed that goes against the status quo. We have to offer better arguments than that, documenting precise reasons why India is different and why it matters. The truth is other countries also have politicians who worry about getting re-elected. And other countries also have poor people who are hurt by inflation. The move to make central banks responsible for inflation management was also an attempt to get the politicians out of the price setting and inflation process. If Brazil, with historically dysfunctional politics and hyperinflation not so long ago, has lower inflation than India today, we may want to ask whether its central bank’s mandate of price stability is precisely what has enabled it to withstand political pressures and achieve the goal. The consensus that maintaining low inflation is the central bank’s job, and its only job, did not develop overnight in those countries, it took time. It is our hope that this consensus will develop in India also.