Reimagining Robert Lucas

The Reserve Bank of India's (RBI) monetary policy announcement did take the market by storm.

- SOUMYA KANTI GHOSH

A jumbo rate cut of 50 basis points (bps) (anticipated by SBI research) along with a staggered cash reserve ratio (CRR) cut of 100 bps but with a stance change left the market flummoxed and on its toes to guess the RBI's next move.

However, a closer look at the RBI's policy statements post-Covid-19 reveals a clear sense of purpose.

In effect, central bank communications across the world have been the subject of much intellectual discourse, particularly after the pandemic. This practice was initiated by Sveriges Riksbank. Many large central banks, such as the European Central Bank, were initially averse to such an idea, favoring a more implicit rather than explicit guidance. In contrast, the Fed Reserve was in favor of explicit forward guidance after the global financial crisis as it was thought to be more useful to assuage market sentiments when uncertainty was high.

Over the decades, central banks have moved towards clearer communication and greater transparency. This has been driven by several motivations. First, central banks have realized that open and transparent communication enhances effectiveness of policy. This shift reflects a shift in the theory of monetary policy itself.