The Uneasy Truce between the Central Bank and the Government

When the uneasy truce between the Government and RBI surfaced last year, it almost seemed like Raghuram Rajan was the sacrificial goat.

With the induction of Dr Urjit Patel as the new Governor and a Monetary Policy Committee ( MPC ), which effectively reduced the far reaching powers of the Governor of the RBI to control interest rates, the intellectuals in the country were worried about a Central Bank that was perhaps going to be more aligned with the Government's policies.

But the recent events at the RBI, prove that this is not true.

The pressure exerted by governments in the past on the Reserve Bank of India was exposed with with D Subbarao's book,'Who moved my Interest Rate? The book is replete with instances of government interferences since 2008 especially from the Finance Minister at that time.

According to the book The Finance Ministry even retaliated by rejecting the re-appointment of Deputy Governers Usha Thorat and Subir Gokarna, claims D Subbarao who was Rajan's predecessor.

History Repeats itself

So it is a story that has been told many a time of how the country suffers when two strong forces oppose. Take the history of England and the constant disagreements between the Crown and the Church, best exemplified by Thomas Beckett and King Henry II.

The recent tiff is only a case of history repeating itself.

When I was a student of Economics we had to witness the Government mis-treating Dr B S Minhas, in spite of the fact that B S Minhas was a celebrated economist. Minhas partnered two Nobel Prize winning economists Kenneth Arrow and Robert Solow in his paper Capital Labour Substitution And Efficiency. A postgraduate from Punjab University, Minhas had a Phd from Stanford. We were very excited as students when he was put in charge of the Planning Commission in the 70s, but he didn't last too long and resigned prematurely, after what we thought was a difference of opinion between him and the political powers of that day.

When he finally predicted that India's economy would grow at 5% or lower annually, and the Government wanted to tell the electorate that the Indian economy would grow at 6%+, the irreconcilable differences finally forced Minhas to resign. 

The Inflation-Growth Paradox

The relationship between inflation and economic growth is one of the most popular macroeconomic issues among central bankers, policy makers and macroeconomists. The relationship between inflation and economic output (GDP) is a tedious one and plays out like a very delicate dance where each intertwines the other.

And so the paradox continues. The government always wants lower interest rates because their performance on the economy is being judged on growth of the economy while the central bank would have to balance this with inflation rates. This is the crux of the problem and the overall constant tussle between the Government and the RBI. 

When the RBI refused to reduce rates this week, the Government hit out at the RBI once again. The rift is now out in the open especially after Urjit Patel told the press that MPC members had rejected a call for a meeting with the Finance Ministry.

It's a sure sign that in spite of the Government having 3 nominees on the MPC, the members are taking a decision in favour of the nation rather than in favour of the government which is exactly what they are expected to do.

John Maynard Keynes is once known to have said 'If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.' 

But then not all the economists on our Monetary Policy Committee are exactly dentists!

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