We have seen this movie before

In the 1970s, the oil shock kicked up inflation all over the world. At the time, monetary policy was poorly structured the world over, and governments did all kinds of silly things in combating inflation. This messy combination of policies helped trigger of the painful period of `stagflation'. For economists, though, it was a great period in that it triggered off new thinking about what monetary policy should do. These new ideas have reshaped monetary policy in all high-income countries. New ideas of monetary policy have helped usher in the `great moderation' where recessions are shallower and shorter. I have an article We have seen this movie before in Financial Express today where I interpret India's problems with monetary policy and inflation from this point of view.

Critical appointments watch

Position	Date	Outcome
Chairman, Finance Commission	November 2007	Vijay Kelkar, 14 November 2007
Comptroller and Auditor-General	January 2008	Vinod Rai, 17 December 2007.
Secretary, Dept. Financial Services, MOF	January 2008	Arun Ramanathan, 8 January 2008.
Chairman, SEBI. link, Video on 24 January	February 2008	C. B. Bhave, but do see this, 14 February 2008.
Two members of SEBI
Chairman, IRDA. link, link	May 2008
Governor, RBI. link link	September 2008
Chairman and members of Competition Commission. link, link, link

Also see:

• Who will fill the hot seats by Tamal Bandyopadhyay in Mint. 4 January, and the associated Experts speak on regulators.

India needs an `inflation report'

All countries experience shocks to inflation. The countries with badly structured monetary policy regimes are those where these shocks get embedded into the structure of expectations, where inflation is more persistent, where the economic cost of wringing inflation out of the system is higher. Ila Patnaik had an article in Indian Express about care in thinking about fluctuations of inflation, and the urgent need for an `inflation report'.

Here are examples of some well written inflation reports - UK, Turkey. A good inflation report is one that is intellectually sound: it is rooted in a conceptually correct understanding of the macroeconomy. The people writing the report have to be clear-headed thinkers, grounded in modern macroeconomics, who understand what is actually going on in the country. The authors of the inflation report should have no conflicts of interest other than honestly talking about inflation: there should not be an effort at covering up for mistakes or upholding a broken monetary policy framework. And, it must be written in plain English, not mumbo jumbo, so as to influence the thinking of millions of individuals in the economy.

What shapes our outlook for inflation? The INR/USD has depreciated in recent weeks, which will fuel inflation in coming months. The small rise in WPI Fuel will also worsen inflation in coming months. These factors need to be properly understood by the authors of an inflation report. On the subject of exchange rate pass through, while one can do a little work, even elementary eyeballing of a graph is quite revealing.

Comment on inflation targeting for India

Tony Cavoli and Ramkishen Rajan have a interesting comment on the question of inflation targeting for India. Towards the end, they have a particularly interesting paragraph:

This leads us to a broader issue as to whether an inflation targeting arrangement errs on the side of policy rigidity and discipline or discretion and flexibility? While the exact balance between flexibility and rigidity will no doubt vary between countries (and possibly over time within a country), broad rules of thumb suggest: (a) the less credible the central bank (i.e. poorer its inflation-fighting track record); (b) the less its technical ability; and (c) the lower its political independence, the more advisable it is to pre-commit to a strict or hard inflation target (i.e. preference of a rule over discretion).

FRBM: A post mortem

I wrote an article in Business Standard titled FRBM: A Post Mortem.

Monetary policy must respond to changes in future inflation

Writing in Mint today, Vivek Moorthy argues that there is a conflict between inflation targeting and pre-emptive attacks on inflation.

Because monetary policy impacts upon aggregate demand and hence inflation with a lag, monetary policy formulation must necessarily be concerned with forecasts of inflation. Inflation targeting inherently means : watching future inflation and modifying the short rate so as to influence future inflation.

If Vivek is saying: It's silly to target last month's inflation, I could not agree more. The job of monetary policy is to anticipate future shocks to inflation and respond to them well ahead of time. Last month's inflation is an input into forecasting future inflation, and is only one input into this task. A smart inflation targeting central bank must forecast inflation, and act on what it sees in the forecasts.

As an example, when RBI setup an INR/USD depreciation of 9.7%, from 39.12 on 1 Feb to 42.93 on 22 May, it was easy to forecast that this was going to exacerbate inflation over a horizon of roughly 4 months. We know that a shock to the currency of 1% induces a shock of between 0.2 and 0.3 to WPI over a horizon of roughly four months. In other words, a shock to WPI of 2 to 3 percentage points is in the offing for WPI data from June to September, purely owing to the movement of the currency. Such empirical strategies can yield a lot of insight into future inflation.

I think a key strength of an inflation targeting central bank is that it is not in a fog of conflicting goals. There is only one goal. The entire organisation is focused on one thing. This generates better work on forecasting inflation and acting on these forecasts.

While on this subject, do read this piece about the `Taylor principle'. This is a necessary condition for a sensible monetary policy, and it's entirely phrased in terms of shocks to inflation that is expected at future dates.

Radical Islam is evolving

Lawrence Wright has an article in The New Yorker titled The Rebellion Within about a key Islamic thinker moving away from violence. Then, see The Unraveling by Peter Bergen and Paul Cruickshank, in The New Republic. These threads are put together by Stephen Fidler in Financial Times. And, James Traub has an article in The New York Times about a pioneering liberal effort in Pakistan: The Lawyers' Crusade.

Steve Jobs and others have worried that `people don't read anymore'. The Internet has, indeed, changed reading habits; it does seem like there is more consumption of article-length pieces rather than book-length pieces. But the Lawrence Wright article linked to above is all of 13,866 words (!) or roughly a fifth of a good sized book. I know of no outlet in India that would carry pieces of this length.