How should one judge the performance of a Central Banker? The usual answer 'by the results - as is the case with any other profession,' is not appropriate in the case of Central bankers as Bastiat points out because the subsequent effects are not generally foreseen. Consider the two previous Central bankers of the US Fed - Paul Volcker and Alan Greenspan - and the public reaction to their policies when they were in office.

Effigies of Paul Volcker were burnt in the Capitol as he raised the short-term interest rates in the US to a mind-boggling 22 per cent during the early 1980s that plunged the US into its worst recession since the Great Depression. Greenspan, on the other hand, was hailed as a 'Maestro' and was conferred 'Knighthood' by the British Queen in the early part of this decade for handling one of the longest, uninterrupted economic expansions the world has ever witnessed.

A serial bubble man…
Two decades after the infamous treatment meted out to 'Tall' Paul, he is now recognized widely as the person who broke the back of inflation during the stagflationary 1970s, while Greenspan these days is forced to begin every speech of his with an it-is-not-my-fault introduction. The world is still in the early stages of realising that Greenspan was nothing more than a serial bubble-man who literally threw a lot of money at problems that first resulted in the Nasdaq bubble and then in the more recent housing bubble.

The point is that the actions of Central bankers often takes years to manifest themselves ie the short-term impact of any monetary policy could be vastly different from its long-term impact (refer to previous articles at http://financial-musings.blogspot.com to understand the rationale). Besides, a lot of macro-economic variables such as the long-term growth conditions are quite outside the control of a Central banker and, to that extent, their hands are forced by what they can and cannot do. Therefore, the actions of a Central banker ought to be viewed in the context of the macro-economic conditions they are operating and their adherence to sound monetary ideals in the formulation of their policies.

What are these sound monetary ideals that I am talking about? They essentially boil down to money supply, interest rates and creation/adherence to market institutions/solutions. I have explained below as to what constitutes a sound monetary policy in terms of the above mentioned parameters.

Having defined as to what constitutes sound monetary ideals, we are now in a position to judge how Dr.Reddy has delivered on these parameters. But before that, it would probably be useful to judge the two US Fed protagonists we had referred to earlier in our discussions.
 
Paul Volcker - his effigies were burnt...
After a highly inflationary US Fed under Arthur Burns during the early 1970s, Volcker inherited a Central banker's nightmare scenario of stagflation ie a recession in conjunction with high inflation. Volcker recognised the underlying inflationary pressures and quite rightly increased interest rates dramatically while cutting back sharply the growth in money supply. While the immediate impact was a severe recession in the US, these actions were precisely the reason behind the end of 1970s commodity boom and one that laid the foundations for the subsequent two decades of uninterrupted economic expansion that we witnessed.

The Twelfth Night Shakespeare quotation of Some men achieve Greatness fits no Central Banker better than Paul Volcker.

Alan Greenspan
Greenspan, on the other hand, inherited an economic situation in which commodity prices were on a downward spiral with a very benign growth environment and yet, at every hint of trouble ie the 1987 stock market crash, the savings and loan crisis of the early 1990s, the long term capital management debacle during the late 1990s and the dot-com bust - Greenspan relied on one solution ie reduce interest rates and print more money. While these actions prevented an immediate recession, they have also resulted in the creation of huge imbalances in the US economy (the unprecedented housing bust, negative savings rate, trade deficits,…), while also directly contributing to the currently ongoing commodity boom that is resulting in high inflation throughout the world.

Now of course, the present US Fed chairman Bernanke is facing the brunt of all the inflation that Greenspan created. If anything, the timing of Greenspan's exit from the US Fed was perfect.

Judging Dr. Reddy - not a pretty scorecard
So how does Dr. Y V Reddy fare in terms of the parameters defined? Interest rates are negative even while using the RBI's statistics of inflation and money supply growth at 20 per cent is substantially higher than the GDP growth rates.  Despite the promises of Reddy that inflation would come down over the next six months, these factors are going to result in even higher inflation in the months ahead. Obviously, this is not a pretty score-card, especially given the conducive growth environment that Reddy had inherited at the start of his tenure.

But the greatest fault with Reddy is not the inflationary policies that he pursued, but his deeply flawed understanding of economics. While Greenspan can be quite justifiably faulted for his policies, his understanding of economics could never be questioned. His essay, Gold and Economic Freedom (quoted in 'The Objectivist' and reprinted in Ayn Rand's Capitalism: The Unknown Ideal) remains the best exposition of the Gold Standard to date and subsequent to demiting his post in the US Fed, Greenspan has been fairly accurate in his prognostications of the credit crisis. Just that Greenspan did not follow through on his convictions while in office.

A throw-back Nehruvian socialism...
In contrast, Reddy's understanding of economics is really a throw-back to the days of Nehruvian socialism. He has defended price-controls as a way to manage inflation. Reddy justified the recent fuel price controls by the government by saying "…we may keep the price rise in abeyance rather than allow it to pass through. Which again means there will be a moderation (in inflation) on account of fuel."

On the fundamental issue of inflation, Reddy has on record stated that the current high inflation is a result of the high growth we have had over the last few years. While an average politician can be excused for making such fundamental gaffes in justifying inflation as an acceptable trade-off for growth, when a Central banker makes the mistake of confusing the true cause of inflation, it indeed is very shocking. Jim Rogers might well have said: ""Reddy should go back to school and study Economics 101."

Reddy's weak grasp of fundamentals also ensured that he did not foresee the coming increase in energy and food prices. In 2006 when crude hit $50 for the first time, Reddy referred to how RBI was managing the 'Oil Shock.' Well, when Central Banks debase a currency by printing more of it (18 of the top 20 Central Banks are expanding money supply in double digits), prices rising is a very logical consequence of the monetary expansions and I find it rather amusing that Reddy referred to the price increases as 'shocking.' As I have explained, the rise in prices of food and energy was entirely predictable following the first principles of economics. Despite the record energy and food prices that we have witnessed in the recent past, we are still in the very early stages and I really wonder what words the RBI would use to describe crude at $200 and then $300 over the next few years.  
I can give numerous other examples, but I presume the point is made. In Reddy's defence, he probably had the right intentions (though I have no evidence to prove this other than the genial nature of his interviews and the seemingly likeable nature of his personality). Had my review of Reddy to be based on his performance as a popularity contest, it would be difficult to give anything less than an "A+". But, as Volcker showed, the job of a Central banker is anything but. With his terribly flawed understanding of economics that would have impaired whatever little conviction that he might have had, Reddy allowed the RBI to be arm-twisted by his political masters into running an inflationary policy.

I come from the Austrian School of Economics that believes an inflationary policy does not make sense under any circumstance. As the Austrian School explains (and something that history has repeatedly proven), the function of a monetary policy is best left to the free markets through a Gold Standard and by abolishing the fractional reserve banking system that requires a Central bank for its very survival. In this article however, I have not judged Reddy as a Von Mises or a Rothbard (the Gurus of the Austrian School) would have done. Even Keynes would not be able to justify the monetary policies followed by Reddy.

Shakespeare had said: "some are born great, some achieve greatness and others have greatness thrust upon them." In running an inflationary monetary policy at a time when there was little justification for the same, Reddy has exposed the incomplete nature of Shakespeare's quotation. There should have been a fourth category that should have read: "some have greatness thrust upon them and they blow it."