Central banks' delusions of grandeur

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 Central banks' delusions of grandeur

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• Shifting mandates: The central banks of Western nations are changing their monetary policy approach very rapidly. No one knows the possible outcomes, and there's no debate either. The RBI must guard against copying the same changes, as India is not a developed but a developing economy.
• US Fed's inflation approach: The biggest change is what the Federal Reserve of US intends to do. It is now targeting "an average of 2 % inflation target for some time" rather than an absolute target. So inflation may go beyond 2 % also, and Fed will claim it was only making up for previous low inflation phases.
• Why inflation targeting: The reason central banks have targeted inflation all these years, is that the markets were given clear, transparent signals about the monetary strategy. A fixed target reduced the bureaucratic discretion with central bankers. Now the "average of 2% for some time" brings a lot of discretion. There is scope for politicians to interfere now.
• Why the shift: For many decades, tight labout markets (low unemployment) always meant higher inflation possible in near future. Wages would go up in tight labour markets, and as they outrun the productivity gains in goods etc., inflationary pressures build up. So central banks would tighten policy once labour markets would tighten. 
• Since 2016: The Fed tightened the policy (raised the rates) since Trump came to power as US labour market was doing well. But inflation never arrived! 

1. That was because Unions are dead, and gig economy has made labour compete with itself for work. 
2. Wage growth is down, and nature of work is changed now. Digitalisation has made productivity changes tough to measure. 
3. Work from home in multiple jobs is the new norm. Demography in West has changed.
4. These strutural changes are deep, and even deeper than 1920s assembly line of 1980s deregulation. Central Banks feel the did to "do something"!

• So more inflation is ok: The thinking is that 'let us allow slightly higher inflation as long as more employment is generated'. But this desire to maintain "maximum employment" is flawed because the definition of employment has changed in 2020. Central Banks are full of arrogance now as their actions are driving all stock markets! But can they reverse demographic and technological changes? 
• Other dangers: The Fed's actions will lead to even the ECB (European Central Bank) reassessing its own strategy. President Christine Lagarde has indicated that. Will India's RBI too follow the same path?
• Choices for RBI: If RBI chooses the new Western model of inflation targeting, it will be making a mistake. Why? The world has some demand left for risk-free debt, so the paper issued by Western nations can still be sold. Indian paper isn't that. RBI has worked very hard to get inflation-targeting as a mandate, and also the independence.
• Don't support corporates: Just because the Fed is directly buying corporate paper does not mean RBI should do so, too. It is not a commercial bank at all. Let the govt. decide to support companies, transparently, using taxpayer money. The RBI should not do that, through the hidden future inflationary tax.
• No inflation please: The RBI MPC's composition will soon change (new independent members). Let them not allow loose inflation targeting like the West, for India had faced many years of entrenched high inflationary expectations. India is not the West, and the Western central banks are anyway deluded into their egomaniac ways!

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