Even central banks need 'capital' infusion (RBI cannot allow itself to become a slave of outdated ideas)

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 Even central banks need 'capital' infusion (RBI cannot allow itself to become a slave of outdated ideas)

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• What is the Central Bank : It sits at the apex of a nation's financial system, and is tasked with ensuring its financial stability. In fact, they ensure capital infusion from time to time, into stressed commercial banks. And what of the Central Bank itself? Does it too need capital infusion?
• Idea of capital : Central Banks make money by surplus from operations, and pay dividends to governments. And capital is funds and ideas, both.
• Indian central bank : We cannot assume as settled its role, for ever. We need to question how it may change with time, given the various challenges being posed. On many matters, the RBI seems to disagree with the government of India.
• What RBI did in past 5 years : There is one area of complet agreement, though! The RBI and the GoI have agreed totally on the monetary policy direction. It was all about running a low-inflation, deflationary policy, using fiscal contraction and monetary tightening. Was that good for the economy, though?
• Washington Consensus, post the USSR collapse : In the 1990s, as the Soviet Union and its communist east European satellites collapsed, the US had a field day. It built the Washington Consensus which said that -

1. Low inflation is desirable, and 
2. Small budget deficits are desirable.

• The Consensus lasted 15 years, till 2005 or so. Everyone (including India) thought that all business cycle oscillations were finally tamed! 
• The 2008 global financial crisis : It started from the US housing market crisis, and quickly spread worldwide. India was hit, too. Actually, a long period of low inflation ("the great moderation") had ended in this crisis. 

1. Growth slowed and unemployment rose
2. Obama admin. intervened via relief bailout packages
3. The US Federal Reserve allowed money supply to grow fast
4. Fiscal deficit rose 3X, but inflation has not risen! 

• Macroeconomics 2.0 : The global crisis 2008 has challenged all basic concepts of macroeconomics - 

1. Monetary policy based solely on inflation-targeting cannot remain the main plank anymore
2. Fiscal policy must be used when needed, and 
3. Financial regulation is a must.

• General consensus : Many agree that the pre-crisis approach of low infation targeting, inflexible fiscal policy (low budget deficits only) and lax regulation for financial sector is not preferable anymore. India is doing the exact opposite (low inflation, strict budget deficit control, lax regulations).
• Govt claims : The GoI takes credit for 'macroeconomic stability' basically meaning low inflation. But if unemployment is steadily rising, it is of any use? The RBI is unnecessarily focused also on fiscal deficit of the government, while it is making mistakes of its own.

1. Mistake # 1 - The real policy rate has gone up a lot, ever since inflation targeting commenced (from around 2013). Borrowings from formal sector are down, affecting investment. Inflation was trending downwards anyway, and low oil prices sped it up.
2. Mistake # 2 - Allowing the huge crisis at IL&FS to spiral out of control, and allowing NPAs to spiral out of control. 

• Two things RBI must do : It must not yield to government pressure. And it must have a modern thinking on macroeconomics.
• Summary : The world of macroeconomics has undergone a complete change in past 15 years, with low inflation not the angel it was assumed to be earlier.

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