A little more conversation: Greater transparency is key to better monetary policy transmission and central bank accountability

Rate actions by central bank monetary policy committees have a way of grabbing eyeballs. So, it was at the US Federal Open Markets Committee (FOMC) meet chaired by Fed chair Kevin Warsh last month. In the will-he-wont-he-cut-rates debate in the run-up to the meet, talk was mostly about whether he'd be Trump's 'sock puppet' and cut rates, or show he's his own man and hold rates as warranted by macroeconomic fundamentals. (A hike was never on the cards. )

It was no surprise then that, even as markets and central banks breathed easy when the Fed kept rates unchanged, attention remained focused on future rate actions. Not on another pet theme of the new Fed chair-a reversal of how monetary policy is communicated, from greater openness to a less-is-more idiom. In a throwback to the days of former Fed chair Alan Greenspan, the policy statement was markedly shorter. It omitted forward guidance, and though there was a 'Summary of Projections' as usual, Warsh desisted from providing his projections.

What's clear is that the new chair is no fan of openness when it comes to central bank communications. In the process, he has, willy-nilly, focused attention on an esoteric, but oft-neglected, aspect of monetary policy-the mumbo-jumbo that passes for central bankspeak. 'What I've learned at the Fed is a new language called 'Fedspeak.' We learn to mumble with great incoherence,' is how Greenspan once described it.


The question is whether what was appropriate half a century ago is best in today's volatile, AI-driven times. The danger is that other central banks, including RBI, will follow the Fed's lead and reverse the move to greater transparency. Warsh's argument that forward guidance boxes the central bank in and forces it to do what might not be suited to a changed situation is hard to accept. If there's one thing the global financial crisis (GFC) should have taught us, it's the danger of allowing markets to lead central banks, rather than the other way around.

Markets can be, and often are, out of sync with reality for long periods of time and suddenly seize up. With catastrophic consequences for the real economy. It's the job of central banks, with their store of institutional knowledge, honed over decades-and, arguably, guised by some of the best brains-to guide markets whenever they turn irrationally exuberant. Not wait, like Greenspan, for the bubble to burst and then pick up the pieces.

This is particularly important in EMs like India, where financial markets lack depth and maturity. Communication in the form of forward guidance is a powerful tool. It helps guide the markets in the direction the central bank wants.

In India, RBI controls short-term interest rate. But rates that affect the economy-like yield on 10-yr treasury-are influenced by investors' expectations for inflation and economic growth. By telegraphing its next move, RBI can cause those longer-term rates to change even before the bank adjusts its own benchmark rate. It can also help suppress volatility and anchor market expectations. 'Open mouth operations', in former RBI governor YV Reddy's words, are as important as open market operations.

In what can only be called a prescient counter to Warsh's criticism of forward guidance, in a 2008 speech at the Bank of International Settlements (BIS) annual conference in Luzern, Switzerland, Reddy drew a distinction between 'communication' and 'commitment', saying communication is not pre-commitment. 'Even when there is a pre-commitment and some reversal is needed at some stage due to unforeseen circumstances, a detailed and timely explanation for deviating from the assurance helps clarifying the situation.' Today RBI does give forward guidance. But, unfortunately, it seldom provides a detailed explanation for deviations from its projections.

Fortunately, RBI is no longer as remote or opaque as it was. Today, under Flexible Inflation Targeting (FIT) regime, we have 6 bi-monthly meetings of MPC, followed by the governor's press conference. But the best communication is never one-sided. It must be two-way if it is to be effective.

True, RBI is now more approachable, and though still imperious, is more open to question. But it needs to do more. It could, for instance, take a leaf out of the Fed's book and institute something like 'Fed Listens' programmes, where policymakers engage with a wide range of organisations and the public to hear how monetary policy affects daily lives and livelihoods.

Like Bank of England, which releases the minutes of its MPC meetings the next day (the Fed releases it after 3 weeks), it could cut the time between MPC meetings and publication of the minutes from the present 2 weeks. It could also make its letter to the government explaining why it failed to meet the FIT target for three consecutive quarters public.

Greater, not less, transparency is the key to ensuring both better monetary policy transmission and accountability of central banks. RBI may have come some way from its earlier ivory tower approach. But it still has a way to go. It must continue down that path. Warsh or no Warsh.