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     Monetary Policy in a Globalized Economy
     In his new book, Rakesh Mohan, a Deputy Governor at the RBI, explains things from a practitioner’s perspective. The main message:
     life is tough, says T. C. A. SRINIVASA-RAGHAVAN.


In the beginning there was money but no policy. Today, it is the other way around. The change began to take place in 1913 when JP Morgan decided, after the banking crash of 1909, that it was simply too boring to keep on rescuing banks.

So he came up with the idea that there ought to be an institutional system of rescuing banks and, at one remove, the financial markets. Thus was the US Federal Reserve born. Its sole task was to ensure that banks and other horrors that inhabit the financial sector didn’t go down all together, for that meant a lot of pain for a lot of people.
     Enter, Bentral Banks   

This function came to be known as central banking. It has worked quite well on the whole. But when it has failed, it has done so spectacularly. The reason is simple. Central banks are supposed to calibrate the level of economic activity by keeping any eye on monetary variables, such as money supply, credit growth, financial instruments and, of course, that mother of all monetary variables, the price of money or interest rates.

When they take their eyes off, as Alan Greenspan is accused of having done, economies tend to rattle and rumble. Sometimes, they crash. A central bank’s job was easier when countries were not open to each other. But once they began to integrate1980s onwards, things became harder. In due course two views emerged. One was that of economists who looked at data from the past and suggested ways of dealing with current and future domestic monetary policy.

These views, as befits economics, assumed both politics and reality away. The other view came from practitioners who had to contend with both. This led to the view that the context of monetary policy was important. Dr Rakesh Mohan, a Deputy Governor of the Reserve Bank of India (RBI) almost throughout this decade, is a leading exponent of the latter view. Since, for the last seven or so years, the RBI has been treated to non-stop heckling by economists and journalists, Dr Mohan explains things from what he calls a practitioner’s perspective.

     Some Puzzles

His new book, Monetary policy in a Globalised Economy: A Practitioner’s View, is a collection of some of his better speeches. It sets out the essentials of monetary policy making in a highly uncertain world. The reader is left in no doubt as to how hard the exercise is and how iffy the calls are. One of the best essays/speeches, made in 2005, was called “Some Puzzles for Contemporary Monetary Policy”. Dr Mohan set out six of them.

They are: (1) the US dollar appreciating despite increasing US twin deficits, (2) soaring oil prices accompanied by strong global growth, (3) long term bond yields falling in the presence of Fed Fund rate hikes, (4) low consumer inflation in the presence of abundant liquidity and increasing asset prices, (5) strong global growth accompanied by slowdown in global saving and investment rates, and (6) the phenomenon of low inflation despite currency depreciation. The question is, how do you devise monetary policy when everything you have been taught is stood on its head? As you read on, you realise that there are no clear answers.

You can only cast your bread upon the waters and hope that when the whole edifice begins to shake and quiver it will not come crashing down. The essay Monetary and Financial Policy in response to Global Imbalances gives the reader an insight into what those in charge at the RBI actually have had to grapple with in the last few years. It is written in the usual RBI style, so you have to struggle a bit to figure out what actually was occupying the mind-space on the 18th floor.

Nevertheless, it is worth a read, not least because Dr Mohan says that “…whereas the existence of global imbalances is well recognised, there are still no definite answers on its possible impact and what policy responses need to be considered.” This was in November 2006.

     Missing the Iceberg
Everyone was peering into the gathering gloom but could not see the iceberg that lay ahead. Four months later, the first signs of the impending crisis had begun to surface. And in July 2007, Bear Stearns had gone under and sub-prime became a household word. This makes the essay Central Banks and Risk Management (November 2006) worth a careful read.

It also leaves one wondering as to why no one did anything a la 26/11. Dr Mohan says that while nasty shocks have not been absent, by and large, the global financial system had done all right till then. But, he adds, “potential fault lines have emerged in corporate governance, auditing and accounting standards and prudential norms, which have been receiving close scrutiny from policy makers...

The task is to remain alert and proactive, identify and address newer risks, eschew harmful incentives and adjust the regulatory environment to address any unforeseen contingency.” The new Home Minister can use that last sentence in one of his speeches, for it remains as true of terrorism as of the financial sector.