They are all Greenspan now

India8217;s central bankers are bringing the economic house down. Let8217;s question them, not fete them as oracles

In the post-Alan Greenspan world, it has become fashionable for central bankers with their new-found aggressive autonomy to play the role of conductors of the macro-economic orchestra. Whether there in fact is a musical score for them to conduct is a matter of doubt. As far as most of us know, central bankers of sovereign countries provided they have not surrendered their independence to trans-national entities like the European Central Bank can control high-powered money the quantum of money that commercial banks keep as cash. Central banks cannot control the ratio of this measure with broader money supply measures like M1 or M3. Admittedly these ratios do not vary much over the short-term. Central banks cannot control the velocity of money. This too does not vary much over the short term, but in the medium term this does keep changing.

We also know that we know very little about macro-economics. Economic pundits can best be compared to neuro-surgeons operating not with laser-based scalpels, but with clumsy axes and saws. We do know from empirical observation that if money supply is increased this time period, then in subsequent time periods 8220;with variable lags8221; nominal GDP does go up and similarly with money supply decreases nominal GDP does go down. We have no precise estimates of how long these lags are 8212; if you reduce money supply this quarter, nominal GDP may decline next quarter or may be three quarters from now, we just do not know. We also know that on the way up, prices get impacted more, that is, if money supply is increased, prices go up more than real GDP and on the way down real economic activity gets impacted more; that is, if money supply is decreased, real GDP declines more than prices.

Based on this very slender body of empirical knowledge, Alan Greenspan managed to acquire oracular status. Not only could this magician control high-powered money which we all concede, but he could control global liquidity, prices in the US and elsewhere and engineer proverbial soft landings and finely-honed take-offs for the world economy. That Greenspan never claimed these powers is irrelevant. He allowed fawning admirers to say so and did not contradict them. The team of macro-economic tinkerers led by him got involved in oracular posturing in the domain of asset prices. Apparently it was both possible and appropriate for the omniscient Federal Reserve to express opinions on asset prices be they prices of financial or real assets and of course influence did I say control? them.

What America does for better or for worse becomes fashionable in distant outposts far from the glamour of the metropolitan centre. Many of the supporters of the recent monetary tightening in India have based their arguments not just on prices of goods and services which measured by our indices are rising, but also on the 8220;exuberance8221; of asset markets, particularly the real estate market. The prices of real estate have been rising quite rapidly in the recent past in urban India, in the big cities as well as in smaller ones. Of course, one could attribute this to increased wealth among potential buyers, ill-conceived supply side constraints imposed by moronic antediluvian city administrators or to the fact that after five decades of socialist planning where people wanting to buy homes was considered unpatriotic, undesirable, etc, based on which banks were prohibited from lending for this activity, banks had finally been allowed to lend to people to buy homes, hence converting latent demand into monetised demand. In any event, we are now told that apart from the goal of bringing down prices of onions, monetary tightening is necessary to deflate the real estate bubble.

I would submit that it all depends on how you choose to measure inflation, prices, bubbles and so on. If the per square foot price of apartments is what you wish to impact, I guess an increase in interest rates will bring them down somewhat. On the other hand, if you look at housing as a consumption item, it would appear that by increasing EMIs for housing loans, you actually drive up the cost of housing measured in EMI terms which is the way most individuals dealing with real instead of abstract cash flows do rather than in per square foot terms, one could argue that an increase in interest rates increases inflation at least as an ordinary home-owner thinks of it rather than bringing it down. Clearly, it all depends on what you measure and how you choose to look at the impact of the item measured. We do know that from a middle class buyer8217;s perspective, homes have become more expensive not less so after the recent interest rate hikes. The fact that the per square foot rate is under downward pressure hardly matters to the person who now has to pay higher EMIs. For such people, inflation has gone up and gone up directly as a result of the interest rate hike. Maybe if we designed a 8220;different8221; way of measuring inflation, based on the reality of EMIs, someone out there will pay attention.

The pretence that we can fine-tune our short term macro-economic destiny is an ill-conceived one based on no theoretical paradigm and on slender, confused empirical data. We can be certain that we do not have scalpels at our command money supply and interest rates are sledgehammers at best. Not only are we poised to seriously hurt the buoyant residential housing sector in our country directly hurting home-buying which is critical both for one8217;s well-being and one8217;s dignity as a person, but with some lag the extent of which we do not know nominal GDP growth will definitely slow down and the impact will be not so much on prices but on real GDP. Is this what we want as a country? Should we not debate this more rather than accept the ill-founded 8220;wisdom8221; of Greenspan and strangle in infancy a vigorous housing sector and an economy that has recently acquired Sinic aspirations rather than Hindoo ones?

The writer is chairman of Mphasis. These are his personal views