The Governor of Reserve Bank of India D. Subbarao said on Friday that a “calibrated exit” from an expansionary monetary policy poses “policy dilemmas” to the central bank while addressing the three main economic priorities — economic growth, price stability and financial stability.
Delivering the M. Chidambaram Chettiyar Memorial Lecture at the Indian Institute of Science, Dr. Subbarao said the RBI had adopted festina lente — make haste slowly — as its guiding principle while charting its exit route.
Speaking on the subject, “Economic crisis and crisis in economics,” Dr. Subbarao said, “People felt let down by economics and economists soon after the onset of the global financial crisis.” The profession was “discredited and the reputation of the professionals was dented.” “The economic crisis then became a crisis in economics,” Dr. Subbarao said. The profession suffered a “hard landing” after enjoying a prolonged period of “impressive clout and popularity.”
The prolonged period of macroeconomic stability had lulled economists into complacency that they could “manage risk” with great accuracy and efficiency, said Dr. Subbarao. He said one of the “big defects lay in positioning economics as an exact science.”
Dr. Subbarao said economists “designed sophisticated theories, based on sophisticated mathematics and impressive quantitative finesse, deluding themselves and the rest of the world that their models have more exactitude than they actually did.”
The Governor observed that many governments and even central banks adopted risk assessment models that “were flawed in many ways.” “They even failed to factor in low-probability high-risk factors into their models.” Dr. Subbarao urged economists to “stop pretending that they are dealing with an exact science.”
Although there are similarities between the disciplines of physics and economics, there are also substantial differences between the two fields, he said. While physics is governed by immutable laws that are beyond the pale of human behaviour, economics is a social science whose laws are influenced by human behaviour.” “For good economic policy you need good economics, but you need good judgment because no economic theory can capture the capriciousness of the real world,” he said.
Dr. Subbarao said the central bank faced “dilemmas” in assessing when, how and by how much to tighten monetary policy when faced by the threat of inflation. “Even today we are not sure that the global economy is on the road to recovery, and some people are even talking about the possibility of a double-dip recession,” he said. He pointed out that monetary policy was not very effective in tackling inflation that is caused by supply-side factors.
