Every business leaders and HR managers know the importance of balanced scorecard or 360-degree appraisal setting. If you set an unbalanced performance objective, suffering is assured.  For example, if you ask a sales team to focus on only revenue and not profit, the sales guys will sell at discount and achieve revenue but no profit. If you ask a bank to lend and build asset book as sole objective, they will do so without any focus on asset quality.  On the other hand, if you ask a bank to control risk very tightly and ensure no default they will hardly do lending. In Finance, you always balance Risk and Return and efficient frontier is where the two are optimized.

Similarly, monetary policies need to balance both inflation and growth. The objective is to optimize and not focus on one parameter alone. The dual mandate makes sense and not the single mandate.

Central Bank of any country is part of the Government since the money printing and money management activity is one of the core act of Governance. However, the authority to conduct monetary policy is delegated to the central bank and to avoid abuse of monetary policy for short term political gain an arm’s length distance is maintained. Another name of the arms length distance is autonomy of operations. Same is the case with RBI as well as Federal Reserve. In a way RBI, Fed etc. operates with relative autonomy to achieve the performance objective required for the economy.

Current spat between Government and RBI is a function of wrong performance target setting done by Government during 2014-2016 as suggested by RBI. Towards the end of Raghuram Rajan era under a committee of Urjit Patel and amendment made in the RBI Act during the current Government, India adopted “Inflation targeting”.  RBI is now focused solely on CPI with initial target of 4% and a band of 2% to 6% as limits. If the limits are breached, RBI Governor and Monetary Policy Committee is answerable. However, RBI is not answerable if growth and employment suffers in the economy but inflation is within range.

“Inflation targeting” similar to what ECB does as against a “dual mandate” followed by US Federal Reserve. Fed’s dual mandate balances full employment and price stability whereas ECB is solely focused on price stability.

Theoretically if a country controls prices well, then they can ensure real growth. However practically there are times when central bank needs to be accommodative with monetary policy to pull the economy out of potential depression.  US Fed is a good example of the same even though one can complain about long term consequences, at least in short term they have put USA in a much stronger ground during last 10 years. On the other hand, because of the nature of union, ECB could not focus on growth as much as they should have because of multi speed economies within.

Hence for a country like India where a base case inflation is caused by supply side constraints like oil price increase, the possibility of low inflation is rare. So we are left with the choice of inflation reduction alone.  A sole inflation focused RBI will possibly end up strangulating the economy through tight liquidity and hawkish policy. But the blame is not for RBI alone since they are merely operating within the performance objective set by the Government.

Indian Government and RBI should re-evaluate and adapt explicit dual mandate similar to that of US Federal Reserve instead of following one eyed inflation targeting. Faster the flaw is corrected, better we are


Author of this article is Samir Lodha and views and opinions are welcome at [email protected]




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