Whether monetary policy in India works on the basis of rules or the discretion[di'skre-shun(free will,इच्छा से)] of a few, or is a mix of both, is something of a enigma[i'nig-mu(mystery,रहस्य)], as nothing about this facet[fa-sit(aspect,पहलु)] is revealed publicly.
A discretionary monetary policy is one that is formulated on a period-to-period basis, without its having a relationship with the policy of previous periods.
On the other hand, a rules-based policy is somewhat adamant[a-du-munt(inflexible,अटल)]; a model is used unremittingly[ún-ri'mi-ting-lee(continuously,लगातार)] over several periods with the objective of maintaining a stable monetary policy.
Pitfalls[pit,fo(difficulty,कठिनाई)] of policy shift
It is possible that the Centre’s representatives in the monetary policy committee (MPC) may go for faster growth of money to reduce poverty in India.
A rules-based expansion of money, on the other hand, is based on an ongoing process, which may go by steady growth in real GDP and indicative price trends.
The recently set up MPC is expected to adopt a discretionary approach. This is also because of its composition — four representatives from the Centre, three from the Reserve Bank of India, and a no-veto power for the RBI governor. Government representatives with links to the ruling party are likely to accelerate the growth of money, without considering the importance of financial stability.
A rules-based policy would not permit an increase in money growth when GDP growth is falling and prices are rising.
Under the new MPC, there is a likelihood of politically-driven expansion of money stock. A number of studies have established a close relationship between discretionary monetary policy and inflation.
In India, too, the government of the day has pushed money expansion — even by borrowing from the Central bank — to finance unproductive poverty schemes or set up projects with a long gestation period without taking steps to increase the supply of real goods. This is why discretionary monetary policymaking has always been of lower quality than rules-based policy. There is a trade-off between the poverty reduction benefits of faster monetary growth and increased inflation.
An important issue arising from the new MPC composition is whether the Centre’s appointees on the committee can handle the ramifications[ra-mu-fu'key-shun(complexities,जटिलता)] of achieving growth without inflation. It remains to be seen whether the sources of demand for money will be under the control of the RBI, so that it can maintain price stability and monitor the relationship between money supply and availability of goods and services.
Our monetary authorities have generally practised a rules-bound approach, taking into account money supply, interest rates, real GDP growth and movement of WPI. This tradition has remained intact, and helped to provide liquidity to the economy and keep prices in check. However, in the last 10 years, increase in government intervention and pressure of industry on monetary authority have been eroding the power of the Central bank to apply a well-planned monetary policy.
During the last two or three years, interest rates have been changed or modified a number of times under pressure from the Centre and the public. Monetary policy should be rules-based. The public and government should obviate[ób-vee,eyt(avoid,टालना)] tampering with this policy tool
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