Monetary policy must reflect uncertainty in decision-making: RBI's Patra

Monetary policy frameworks and their communication need to reflect the inherent uncertainty in policy making, said Michael Debabrata Patra, deputy governor, Reserve Bank of India (RBI).

 

Speaking at the High-Level Policy Conference of Central Banks in the Global South on November 21, Patra said, “…the optimal level of communication remains the gold standard for all central bankers – too much can create a ‘signal extraction problem’ while too little can keep the markets guessing.”

 

Monetary policy may be 98 per cent talk and only 2 per cent action, but the cost of sending the wrong message can be high, Patra cautioned.

 

 

Patra also highlighted that while monetary policy needs to manage inflation expectations, micromanaging them may be counterproductive.

 

“In terms of targeting the audience, central banks are still learning how best to communicate with the wider public. It is said that communication is the bridge between confusion and clarity. Central banks must engage in constantly refining and upgrading this ‘soft skill’ to make it effective,” Patra said.

 

Unlike in advanced economies, in India, the RBI has refrained from providing forward guidance on policy rates. However, it provided both time- and state-contingent forward guidance during the Covid-19 pandemic.

 

“During the policy tightening cycle amidst heightened global uncertainty and overlapping shocks, the RBI was of the view that forward guidance itself could be a source of policy uncertainty undermining policy credibility. Accordingly, it refrained from forward guidance during the policy tightening cycle,” said Patra.

 

“Nonetheless, the RBI has emphasised clarity in communication, while maintaining a balance between both high and low-frequency communication of monetary policy,” he added.

 

According to Patra, while the utility of forward guidance at very low policy rates is unambiguously proven, its efficacy at higher rates is questionable.

 

This is consistent with the asymmetric nature of the monetary policy cycle – the way down has a lower bound, but the way up is technically unconstrained by any upper bound, he said. Patra added that under heightened uncertainty, discretion in forward guidance has increasingly gained legitimacy among major central banks.