Sri Ram Poudyal:

The Supreme Court has cleared the way for the appointment of governor of the Nepal Rastra Bank (NRB) by vacating the earlier stay order issued against the government. Before this there was a long tussle between the prime minister and the deputy PM over the appointment of the candidate proposed by the three-member committee chaired by the DPM himself as the first choice. The attorney general has held that the person listed as the first choice is not eligible for appointment. These events make a mockery of our governance and of the calibre of the committee members who were in very high positions in the past, not to speak of the convener, who is the DPM himself. The committee members seem to have obediently executed the desire of the convener rather than preparing the list from among the potential economists of the country. The nomination came under heavy controversy because of conflict of interest between the PM and the DPM as each was bent on making his own candidate the governor.

Some think whoever is appointed as the governor cannot bring about miracles in the economy. There is no standard monetary policy that could be followed rigidly by any governor irrespective of circumstances. There are no written rules which would describe how policy would be set in different circumstances. So some discretion is inevitable. And it is this which makes the task of the central bank governor most challenging.

No one can dispute that the central bank has a crucial role to play in economic policy-making, particularly in the context of today’s globalised markets. The economy is at a low ebb.

However, not much thinking is given to how NRB should formulate its monetary policy to address these problems. If price stability is the overriding objective of monetary policy, there is stability as inflation measured in terms of National Urban Consumer Price Index has fallen from 11.4 per cent in 1997/98 to 2.9 per cent in 2001/02, and remained at 4.8 per cent and 4 per cent in 2002/03 and 2003/04. The question is about optimal inflation rate, but NRB is silent on explicit and numerical target for inflation. There is no question that price levels should be sufficiently stable so that expectations of change do not become major factors in key economic decisions. But for this, monetary policy should be thought of as a combination of ex-ante inflation target and a strategy for responding ex-post to unanticipated shocks. The central bank should be able to respond to these shocks before the private sector is able to adjust nominal wages and prices.

What should the NRB do to increase output and employment? There is no rigorous exercise on this, particularly focusing on how the monetary policy transmission mechanism will operate and when it fully works how it would affect output. The Keynesian transmission mechanism is presumed to operate through liquidity preference relation, interest elasticity of marginal efficiency of investment and the multiplier, which may not simply prevail in an underdeveloped economic structure like that of Nepal.

One key challenge the new governor will face is how to conduct monetary policy in a situation of price stability, and how monetary policies should be designed to ensure that inflation does not reappear again. Another important question is how to compromise the short–run trade-off between inflation variability and output variability. Yet another question is how to avoid the ensuing liquidity trap situation or what policy measures to be adopted for stimulating the economy.

Poudyal is professor of economics, TU