The RBI MPC serves no purpose other than cosmetic and should be dismantled

Inflation has become a problem. In this context it’s useful to recall that it’s now five years since the government — heeding advice that India should copy the developed countries of the West — enacted a law that created a monetary policy committee (MPC) to ensure that inflation stayed within a band of 2-4-6 per cent. It hasn’t been able to do that.

Some former governors of the Reserve Bank of India (RBI) had since then said inflation targeting wouldn’t work in India. They have been proved right.

Those who gave the advice to go for such targeting via an MPC helped create the legislation. They were well-meaning economists.

One of them had specialised in finance. Another had specialised in public finance. Both were highly western in their orientation. Neither had much experience of India. In particular, neither knew about its governance structures.

The former thought that calm functioning financial markets had to be the objective of monetary policy. The other thought the MPC would keep fiscal policy in check.

The finance man left in 2016. His successor left in 2018. Their place was taken by a retired civil servant who understood Indian politics and economics very thoroughly.

Since then the MPC has been a largely cosmetic device. It pretends that Indian monetary policy is autonomous of the government, if not quite independent of it. It’s a nice pretence, but like all pretences it is ultimately useless and excites only some economists.

This is because the real power remains with the RBI governor who acts on behalf of the government because there is no other option: that’s how Indian governance structures are. This is what the two architects of the MPC failed to take into account.

When the MPC was first proposed and then discussed, I had pointed out that there were two ways of judging whether it would work or not. One was economic, the other was structural.

Two problems

But such is the force of fashion that the MPC had acquired an unstoppable momentum. However, the time has now come to review its usefulness both in terms of economic theory and governance structures. In India both work against a successful MPC.

In 1975 two economists had figured out why committees don’t work well and, indeed, that committee members try to read the chairman’s mind and vote accordingly.

The formal theorems in this regard were set out by Allan Gibbard and Mark Satterthwaite. Their theorem says that for every committee voting rule, either the rule has to be dictatorial in that a boss chooses the winning outcome; or that the number of possible outcomes is just two; or as mostly happens, you get tactical voting wherein members of the committee don’t vote what they actually want. They second guess the others.

In other words, you can’t trust committees to be 'margdarshaks'. The MPC is just one more in a long line of such committees globally.

Likewise, in the case of governance structures, there are two insurmountable hurdles in the path of RBI’s independence on monetary policy. These hurdles make committees redundant.

One hurdle is that its governor is appointed by the government. The other is the provision in the RBI act that enables the government to order the RBI to do its bidding. It's game, set and match to the government.

This is the reason why the MPC serves no purpose other than cosmetic. It is like the logo on a plane’s tail. It makes no difference if it’s there or not if the plane can fly.

Hence my suggestion: dismantle it. Or at least don’t take it so seriously