New issues in Indian macro policy.

1. Removal of functions from the central bank other than monetary policy.

2. A mandate for targeting inflation.

3. Mechanisms for independence of the interest-rate setting decision from electoral
politics.

4. Mechanisms for accountability, transparency and predictability.

India is not alone in steering macroeconomic policy away from an ill-posed set of in-
struments and goals. As an example, consider the UK, which is now widely seen as a role
model for well functioning policies on fiscal, monetary and finance through the reforms
of the late 1990s. Batini and Nelson (2005) emphasise that the UK spent many decades
floundering on macroeconomic thinking. As they say in their abstract:

Policymaking in recent decades has discarded various misconceptions about
the macroeconomy and the monetary transmission mechanism that officials held
in earlier periods. The misconceptions included: an underestimation of the
importance of monetary policy in demand management until 1970; a failure to
distinguish real and nominal interest rates until the late 1960s; the deployment
until the mid-1980s of ineffective monetary control devices that did not alter the
monetary base; and the adherence by policymakers in the 1960s and 1970s to
nonmonetary views of the inflation process. We also consider developments in
fiscal policy in light of changes in the doctrines underlying U.K. macroeconomic
decisions.

Many emerging markets have grappled with similar issues in recent years. In the decade
of the 1990s, an important source of policy evolution was the contradictions between in-
creasing de facto convertibility and pegged exchange rates. Inconsistent monetary pol-
icy regimes are known to destabilise capital flows, and induce crisis phenomena such as
speculative attacks, sudden stops, etc. In many countries, these contradictions forced a
re-examination of the principles underlying macroeconomic policy.

India has not yet had a crisis deriving from the inconsistent monetary policy regime.
Monetary and fiscal reform is required to achieve a consistent ‘speculation-proof’ policy
framework, to smooth the process of India’s integration into the world economy. The ideal
scenario for the 2007-2010 period involves a reform effort that puts a sound macroeconomic
policy framework into place before such a crisis comes about.

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