Monetary policy is an art of managing expectations, says RBI Governor

Reserve Bank Governor Shaktikanta Das said "monetary policy is an art of managing expectations" as he emphasised the need for an effective communication strategy

Reserve Bank Governor Shaktikanta Das on Friday said "monetary policy is an art of managing expectations" as he emphasised the need for an effective communication strategy amid concerns over rising inflation fuelled by geopolitical developments.

The conduct of monetary policy has undergone notable changes in India and across the world as economies and markets evolved and policymakers gained greater insights into how economic agents interact in a complex economic system, he said while delivering a lecture at the National Defence College here.

"As monetary policy is an art of managing expectations, central banks have to make continual efforts to shape and anchor market expectations, not just through pronouncements and actions but also through a constant refinement of their communication strategies to ensure the desired societal outcomes," he said.

The communication works both ways -- while too much communication can confuse the market, too little may keep it guessing about the central bank's policy intent, he added.

The central bank also recognise that communication needs to be backed by commensurate actions to build credibility and instil wider confidence in policies.

The Reserve Bank of India (RBI) has actively used communication through a variety of tools -- the MPC resolutions and minutes, exhaustive post-policy statements together with a statement on developmental and regulatory measures, press conferences, speeches and other publications, especially the biannual Monetary Policy Report (MPR) -- to anchor expectations, Das said.

The governor informed that price stability under the statute has been defined numerically by a target of 4 per cent for headline Consumer Price Index (CPI) with a tolerance band of +/- 2 per cent around it. The flexibility in the FIT (flexible-inflation targeting) regime comes from provisions to accommodate or see-through transitory supply-side shocks to inflation.

Failure to meet the monetary policy objective is defined in terms of average headline CPI inflation remaining lower or higher than the 2 to 6 per cent band for three consecutive quarters, rather than any instance where inflation exceeds/falls below the target. This helps monetary policy to avoid undue volatility in rate-setting behaviour that may adversely impact growth," he said.

"The clearly defined inflation target and the band, the setting up of the MPC, the explicit accountability mechanisms for defining failure in meeting the target, the detailed resolution and the quick release of individual assessments in the minutes have strengthened transparency and credibility of monetary policy formulation in India," Das said.

Retail inflation breached RBI's upper tolerance level at 6.01 per cent in January, compared to 5.66 per cent in December 2021.

The rise was mainly on account of high food inflation, which jumped to a 14-month high of 5.43 per cent along with an unfavourable base.

Referring to the current global conditions, Das said it was posing complex challenges for central bank communication after about two years of living through the pandemic.

A number of economies, including the major ones, are facing multi-decadal high inflation due to supply disruptions, tighter labour markets, fragility of the just in time inventory management and geopolitical disturbances, he said.

"Central banks are in a bind -- if they act aggressively to contain inflation which may perhaps subside as normalcy returns, they run the risk of setting in recession; on the other hand, if they act too little and too late, they may be blamed for falling behind the curve and may have to do a lot of catching up later which will be detrimental to growth," it said.

Meanwhile, he said, financial markets world over have turned extremely volatile as they have been left grappling with heightened uncertainty over the pace of future monetary policy normalisation.

"Recent geo-political developments have further aggravated the challenges and dilemmas for the central banks. Amidst these uncertainties, central banks have to find the optimal grounds with attendant communication challenges," he added.

Talking about measures taken to deal with pandemic, Das said, RBI's response was prompt and decisive.

More than 100 measures were undertaken since March 2020. Moreover, on two occasions -- March and May 2020 -- MPC meetings were held ahead of the schedule; while two other standalone statements were made by the governor outside the Monetary Policy Committee (MPC) cycle -- one in April 2020 in the early days of COVID-19 crisis and the other in May 2021 at the peak of the second wave, he said.

"These off cycle MPC meetings and standalone statements demonstrated the RBI's readiness to undertake pre-emptive actions. We were perhaps the only central bank in the world to have set up a special quarantine facility with about 200 officers, staff and service providers, engaged in critical activities to ensure business continuity in banking and financial market operations and payment systems," he said.