Central Bank Independence: Just How Much Power Do We Give Technocrats?

A discussion on the ‘scope’ of a central bank cannot be said to be a discussion about its ‘autonomy’ at all, writes TT Ram Mohan.

Finance Minister Arun Jaitley with RBI Governor Urjit Patel and SEBI Chairperson Ajay Tyagi at the Financial Stability and Development Council meeting at the Finance Ministry in New Delhi, on Oct. 30, 2018. (Photographer: Shahbaz Khan/PTI)
Finance Minister Arun Jaitley with RBI Governor Urjit Patel and SEBI Chairperson Ajay Tyagi at the Financial Stability and Development Council meeting at the Finance Ministry in New Delhi, on Oct. 30, 2018. (Photographer: Shahbaz Khan/PTI)

Reserve Bank of India Deputy Governor Viral Acharya created a stir last week with his strongly-worded speech about the danger of governments undermining central banks. It was seen as a warning to the Modi government of the perils of encroaching on the RBI’s turf.

A day later, Finance Minister Arun Jaitley spoke in New Delhi. Without naming any institution, Jaitley asked, “Are we weakening the authority of the elected and creating a power shift in favour of non-accountables? Ultimately at the Centre or state, it’s only the elected who are accountable. The non-accountable are not accountable.”

Jaitley touched the nub of the issue in the current debate: just how much power do governments give technocrats, such as those at the central bank?

When it comes to choosing between politicians and technocrats, the intelligentsia would reflexively plump for the latter. Technocrats are highly educated. They are suave in making their case. Most importantly, they are thought to be better capable of focusing on outcomes over the long-term instead of being guided by short-term considerations such as impending elections.

The last proposition is not as self-evident as it seems. The corporate world is ruled by technocrats, often MBAs from the top business schools, but are, nevertheless, plagued by short-termism. Analysts routinely rue the tyranny of quarter results over decisions taken by corporate leaders.

Similarly, are heads of central banks entirely free from the temptation to make a splash during their brief tenures?

Policy, Its Consequences, And Accountability

Let’s take the proposition further. If, indeed, technocrats are more capable of taking long-term decisions, why leave fiscal policy in the hands of elected representatives? How about a Fiscal Policy Committee that will implement the FRBM Act with more grit than politicians have shown?

The reason that fiscal policy has not been delegated to technocrats is that it has multiple welfare and distributional effects that are best-weighed by elected representatives. Monetary policy, with its focus on inflation, is believed to be less complex in its impact and hence relatively easier to delegate to technocrats.

However, this contention is increasingly coming to be questioned. Monetary policy too can have important distributional consequences and hence vesting it in technocrats can be moot. Low interest rates, such as those that followed the financial crisis of 2007, advantage borrowers over savers; they advantage owners of assets over those who don’t own any. Again, the impact of monetary policy on exchange rates and financial stability again has wider implications that cannot be left entirely to technocrats.

Central bank independence has thus far been thought of overwhelmingly in relation to monetary policy. As we have shown above, in today’s context, even this is not as straightforward as it was in the late 1970s when steps to entrust it to technocrats were taken.

For central banks to claim independence in other matters that often fall within their remit—regulation, for instance—is quite a stretch.

When the United States decided to rewrite regulations for banks, it did not leave the matter to regulators. It was the U.S. Congress that passed the Dodd-Frank Act that defined the framework for regulation.

Paul Tucker, a former Deputy Governor of the Bank of England, addresses the issue of elected representatives versus technocrats in a recent, much-acclaimed book aptly titled, Unelected Power. Neither politicians nor technocrats are infallible. There is a crucial difference, though.

When politicians fail, people can vent their anger by voting them out. They cannot similarly vote out technocrats.

When people find that they have suffered on account of decisions taken by technocrats, there can be an explosion of anger.

Following the financial crisis, that’s precisely what we have seen in the U.S. and in Western Europe, with the many political consequences that have ensued. Any delegation of authority by elected representatives to technocrats must, therefore, rest on sound principles. Only then will authority exercised by technocrats enjoy legitimacy.

Tucker outlines these principles – he calls them the Principles of Delegation. Three of these are worth underlining.

  1. The objective of policy must be clearly defined.
  2. The instrument for achieving the policy must be spelt out.
  3. A mechanism for accountability must be in place. Information on these principles must be widely disseminated so that the public understands what’s going on and why.

These principles are clearly reflected in the mandate for India’s Monetary Policy Committee. There is an objective, namely, the inflation rate, for which a band is specified. The policy instrument is the interest rate. Accountability is ensured by the RBI having to explain to Parliament any deviation from the inflation band.

Finance Minister Arun Jaitley with RBI Governor Urjit Patel, in New Delhi, on Feb. 11, 2017. (Photograph: PIB)
Finance Minister Arun Jaitley with RBI Governor Urjit Patel, in New Delhi, on Feb. 11, 2017. (Photograph: PIB)
Government Versus RBI: Dissent At The Podium

‘Scope’ And ‘Autonomy’

Turn now to some of the issues that Deputy Governor Viral Acharya flagged in his speech last week: regulation of public sector banks, a separate regulator for payments and the transfer of the RBI’s balance sheet surplus to the central government.

To take up the first issue, applying the principles proposed by Tucker, the RBI can be given a free hand in the matter provided we can define the outcomes by which the RBI will be judged. This is not an easy task. Perhaps, over time, we will be able to define some outcomes. Until we do so, regulation must necessarily involve a role for the government.

The creation of a separate regulator for payments is a discussion about the scope of functions of the RBI. It is similar to the proposal made earlier to hive-off the public debt management function from the RBI. A discussion on ‘scope’ cannot be said to be a discussion about ‘autonomy’ at all.

There are full-scope central banks and there are central banks with limited scope. There can be autonomy for both categories.

The question of the transfer of surplus is a discussion about the appropriate level of reserves the RBI should have. Former Chief Economic Advisor Arvind Subramanian, a friend and co-author of former RBI Governor Raghuram Rajan, had argued that the level of reserves at the RBI was above the level at several other central banks. For the government to raise the issue cannot be construed as threatening the autonomy of the RBI.

Technocrats, in general, must be subject to political oversight.

The issues that Acharya has raised can and should be resolved through discussion with the government. The RBI should not try to become what Tucker calls an “overmighty citizen”. That will not serve the cause of the RBI or the nation.

TT Ram Mohan is professor of finance and economics at IIM Ahmedabad.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its Editorial team.