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Structure, Ideas, and Institutions

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History of Monetary Policy in India Since Independence

Part of the book series: SpringerBriefs in Economics ((BRIEFSECONOMICS))

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Abstract

In developing a SIIO paradigm, based on structure and ideas that become engraved in institutions and affect outcomes, to examine and assess monetary policy in India after independence, this chapter surveys relevant aspects of Indian structure, the ideas that influenced monetary policy formation and evolution, and the institutional framework, procedures, and norms of practice in which policy was carried out. Even in a broad brush focus on the main trends, a flavor is given of intricate processes that generate the cold numbers.

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Notes

  1. 1.

    Since the book is a revised version of a monograph written for the first Professor Brahmananda Memorial Research Award, its approach is very much in the tradition set by Dr. Brahmananda. He had himself undertaken a monumental study of money, income, and prices in nineteenth-century India (2001). But starting with his early work (Vakil and Brahmananda 1956), a defining characteristic of his approach was to refine analytical frameworks so that they became relevant for the analysis of Indian structure. Nachane (2003) brings out, with great warmth and affection, both Dr. Brahmananda’s scholarship and his focus on relevance.

  2. 2.

    The original source for the data processed in tables and charts, unless otherwise mentioned, are the Web sites of the Reserve Bank of India (RBI) and the CSO.

  3. 3.

    The table starts from 1970 to 1971 since before that only the budget deficit was reported.

  4. 4.

    Krishnamurthy and Pandit (1985), Rakshit (2009), and Balakrishna (1994) are fine examples of structuralist thinking in the Indian context. Jadhav (1990) surveys monetary models.

  5. 5.

    In Irving Fisher’s version, the quantity theory of money is written as MV = PY. With constant velocity (V) and output (Y) at full employment, there is a one-to-one relation of money supply (M) and the price level (P). Velocity would change with the factors affecting the demand for money such as income and the nominal interest rate. But predictable or stable changes in money demand could be factored into arrive at money supply targets.

  6. 6.

    As late as 1995, Rao and Singh argued that in spite of the overwhelming international evidence on instability of money demand, Indian money, income and a relevant interest rate were cointegrated, demonstrating long-run stability. Even so, their view was that targeting of nominal income, or velocity, is superior to targeting some monetary aggregate, since velocity can be derived independently or residually, without trying to invert a questionable money demand schedule.

  7. 7.

    Brahmananda’s (2001) monetary history was based on the quantity theory of money following Friedman and Schwartz’s (1971) famous US history, but he modified it to suit nineteenth-century India, for example, by including an index of rainfall as a determinant of the price level and an index of monetization as a determinant of velocity.

  8. 8.

    This was not surprising, given that markets were suppressed. Preindependence studies had found significant interest elasticities (Anjaneyulu et al. 2010).

  9. 9.

    M = mH, where m is derived from the two identities M = C + D and H = C + R by dividing the first from the second and then dividing the numerator and denominator by 1/D to get M = ((1 + C/D)/(R/D + C/D)) H (Goodhart 2007). The multiplier can also be written as m = [(D/R)(1 + D/C)/(D/R + D/C)] by multiplying the right side by [(D/CR)/(D/CR)]. The multiplier reduces when (D/R) or (D/C) falls.

  10. 10.

    Even banks used a system of cash credit rather than bills and loans to finance working capital, which reduced their supervision of the end use of credit.

  11. 11.

    The Lucas critique of early Keynesian models was that since the IS-LM and PC were not derived from individual behavior, parameters could change with policy shocks, making the relationships unreliable for the analysis of policy.

  12. 12.

    IMF (2013) finds that the AS curve has become flat in AEs. The reason is better anchored inflation expectations. The reason in EMs is elastic output. But volatile exogenous cost shocks shift up the AS in EMs.

  13. 13.

    In typical closed economy structuralist models, agricultural markets were price clearing with quantities given, while quantities adjusted in non-agricultural markets. Therefore, money supply could affect food prices. But in an open economy, agricultural supplies are not fixed even in the short period since imports are possible (Goyal 2004). Now, the exchange rate affects food prices (Goyal 2010).

  14. 14.

    The cynics view was that this was to ensure the country remained solvent and could continue to make payments to the British (see Anjaneyulu et al. 2010).

  15. 15.

    In the mid-1950s, Rama Rau, the then governor of the RBI, resigned because of pressures from the Finance Minister TT Krishnamachari. The latter imposed a steep rise in the stamp duty of bills that effectively destroyed the bill market that Rama Rau was keen to develop.

  16. 16.

    In 1964–1965, Finance Minister TT Krishnamachari even claimed for the government the right to announce bank rate changes when Parliament was in session. But Bhattacharyya was able to defend the bank’s right to announce the bank rate and was also able to raise rates. Even such “symbolic” rights are important for autonomy (Balachandran 1998, pp. 741).

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  1. Indira Gandhi Institute of Development Research (IGIDR), Mumbai, India

    Ashima Goyal

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Goyal, A. (2014). Structure, Ideas, and Institutions. In: History of Monetary Policy in India Since Independence. SpringerBriefs in Economics. Springer, New Delhi. https://doi.org/10.1007/978-81-322-1961-3_1

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