Monetary policy stances
In an unprecedented and ad hoc move, the RBI cut CRR by 50
basis points a few days ago. This measure, which was clearly
announced to be temporary and short-term, has injected quite some
liquidity into a market that was moving towards a credit crunch -
and most importantly, seems to have restored some confidence into
the system, which will then spin off into a virtuous cycle of
availability of liquidity.
But on a more long-term basis, the RBI is clearly facing some trade-offs. The interest rate channel and the credit channel of monetary policy seem to be acting in conflict - where CRR hikes would lead to an increase in money supply via the interest rate channel (undesirable) but would also inject liquidity into credit markets via the credit channel (desirable). A central bank that has to maintain both low inflation and financial stabiilty is therefore faced with some trade-offs. This is not to say that the current inflation can indeed be tackled via tighter interest rates - but there is still a definite impact of signalling by the central bank.
This raises quite some questions - the first is - would selling off some forex reserves help in this case? It would help with the depreciation of the rupee, help stem some of the mark-to-market losses of holding the reserves and also reduce money supply which may help combat inflation. But how would it deal with the financial stability issue?
The second is the issue of whether or not the central bank is the ideal institution for ensuring systemic financial stability. The Mistry report details reasons for division of these functions - at least of micro-institutional financial stability. Would this help resolve the conflict?
But on a more long-term basis, the RBI is clearly facing some trade-offs. The interest rate channel and the credit channel of monetary policy seem to be acting in conflict - where CRR hikes would lead to an increase in money supply via the interest rate channel (undesirable) but would also inject liquidity into credit markets via the credit channel (desirable). A central bank that has to maintain both low inflation and financial stabiilty is therefore faced with some trade-offs. This is not to say that the current inflation can indeed be tackled via tighter interest rates - but there is still a definite impact of signalling by the central bank.
This raises quite some questions - the first is - would selling off some forex reserves help in this case? It would help with the depreciation of the rupee, help stem some of the mark-to-market losses of holding the reserves and also reduce money supply which may help combat inflation. But how would it deal with the financial stability issue?
The second is the issue of whether or not the central bank is the ideal institution for ensuring systemic financial stability. The Mistry report details reasons for division of these functions - at least of micro-institutional financial stability. Would this help resolve the conflict?
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