Banking on the Governor

THE ‘CLINTON-GREENSPAN’ mix is a fable of intermediate macroeconomics classes in many American universities. The odd combination of surnames refers to a ‘dream’ mix of fiscal and monetary policies under US President Bill Clinton and US Federal Reserve chief Alan Greenspan in the last decade of the 20th century. While classes usually highlight the macroeconomic aspect of the situation, virtually nothing is said about the institutional framework that made the fruitful mix possible in the first place: cooperation between the central banker and the fiscal authority.

In ordinary times, such issues seldom elicit any comment. In politically charged environments with a considerable degree of economic uncertainty, the order of commentary is reversed: macroeconomics takes a back seat and institutional arrangements take a near political hue. It does not help if certain central bankers are popularly considered ‘rockstars’ and not ‘dull and unimaginative bankers’.

Something similar is at play in India currently. Last week, the Governor of the Reserve Bank of India Urjit Patel quit his job after a controversy over government interference in the functioning of the central bank. Patel’s departure was the second one of an RBI Governor after Raghuram Rajan exited in a similarly controversial situation in 2016. The appointment of Shaktikanta Das, a former economic affairs secretary, has been greeted with derision over his lack of economics education. There is speculation—mostly uninformed, as of now—that he will do the Government’s bidding in taking some banks off the hook from the Prompt and Corrective Action framework meant to discipline weak banks, ‘passing on’ the reserves of the RBI to the Government, and easing the flow of money to Non-Banking Financial Corporations (NBFCs).

All these issues are serious matters that have been analysed by economists. On all three, there is little consensus except to say that caution is merited in taking any decision. More work and research are required instead of the breathless commentary on how the Government is out to hoodwink the country.

In the debate over the appointment of Das, these issues have been buried under one banal assertion: his education in history and lack of academic training in economics, seen to make him unfit for the position. It is a dubious argument. There is little doubt that a trained economist is bound to be a good fit in a central-banking role. But it is equally true that as long as a non-economist is supported by a set of economists and a research team that keeps him updated on macroeconomic developments, he should be fine. The next order argument posed is that this is so only if he listens to his team’s advice. This ‘if’, again, is open to question and not entirely accurate. For one, there is little doubt that governments across the world in contemporary times want central bankers who take their concerns into account. But this simple claim is scurrilously described as ‘pliability’.

Even the most reckless government knows that it cannot tame financial markets or weather a currency run, capital flight or any of the macroeconomic pathologies that an open economy is vulnerable to. A credible central bank governor is the lynchpin in a system where financial markets and governments continue to work smoothly. It is a fantastic claim that a ‘pliable’ governor can be used to carry out the Government’s diktats. This argument can be disposed in a simple manner. Suppose a ‘pliable’ governor does indeed carry out the Government’s wishes to the hilt. What next? An economic meltdown is a near certainty under such conditions. Running a government will become next to impossible unless one shuts down all financial markets.

A moment’s thought is enough to alert anyone how fantastic these propositions are. No government wants a pliable governor; at the same time, a rival centre of power where the central banker does what he pleases is subversive of democracy and its institutions.

In the real world, central banks and governments operate—at times uneasily—somewhere between those two extremes. Institutional credibility requires that the temptation to ‘explore’ those extremities is eschewed and a degree of cooperation is maintained between the fiscal and monetary authorities.

For more than two decades after 1992, a degree of cooperation between RBI governors and the Finance Ministry prevailed, with a few minor hiccups in the relationship. In the past five-odd years, however, this relationship came under stress. Depending on one’s choice of explanations, the reasons for this include the return of a strong government and the larger-than-life persona of some governors. Both claims could be true or not. But one thing is certain: the ‘image building’ exercise of some governors—aided and abetted by the press—turned out to be problematic. This is obvious as central bank communication is now considered essential to the job of managing an economy. The channel through which this has a bearing on economic behaviour is the formation of expectations. If a central banker says that inflation is likely in the months ahead, then almost by magic this can turn out to be true even if the economic fundamentals dictate that it is unlikely.

This is one of the reasons why anything said by a central bank governor is parsed for any ‘signals’ that can have economic meaning. From quarterly reports to speeches, anything that emanates from the ‘temple’ is analysed threadbare. It is in this context that central bankers speaking out of line creates more problems than it solves. Consider the effects of a central banker making political speeches. The signal it sends, especially to financial markets, is that all is not well between the person at the helm of monetary policymaking and the fiscal authority. Any government—whatever its political bearing, liberal, progressive or conservative— would be concerned about such behaviour. This scenario had became all too real in India in the recent past.

The apocryphal quip by a Finance Ministry functionary that India had two central bank governors, one who was very voluble and another who was exceptionally quiet, may have been true. What is needed now is a governor who will avoid either extreme and get on with the task of macroeconomic management and smoothing the frayed edges of the institutional relationship with the Government.

As for the Government, it ought to realise the dangers of two governors departing in quick succession. The foremost being the perception that the central bank does not even have the autonomy it is promised on paper. The resort to Section 7(1) of the RBI Act—that allows a government to issue ‘directions’ to the RBI governor—had pushed the relationship into disharmony. It is something of a miracle that the financial markets did not witness prolonged turmoil after that, something warned of by Deputy Governor Viral Acharya in a speech that made the confrontation public news in late October. But it will be wise to remember that it was miraculous. It will be well advised not to tempt fate.

Shaktikanta Das deserves a quiet tenure, some breathing room and freedom from sniping over his academic qualifications and alleged ‘pliability’ at the hands of the current Government. Reckless commentators should bear in mind two facts. One, Das has served in economic management roles under two different governments. Two, when Urjit Patel assumed charge as Governor, similarly tactless claims about being pliable had greeted him. The same commentators are now being forced to admit how the ‘meek Gujarati’ kept the flag of RBI’s autonomy flying high. Perhaps it is time for everyone to be more circumspect and get on with the real task of managing the Indian economy.

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