Explained - Urjit Patel Committee On Monetary Policy Reform

Mrunal (http://mrunal.
org/)
[Economy] RBI Urjit Patel Committee: 4% CPI, Nominal Anchor,

Multiple Indicator, Monetary Policy Framework Reforms (Part 1 of 2)
Banking (http://mrunal.org/category/economy/banking) / 12 months Ago /

101 Comments (http://mrunal.org/2014/02/economy-rbi-urjit-patel-committee-4-cpi-nominal-anc
1. Prologue
2. Monetary Policy reform: Where to focus?
1.
#1: Focus on Exchange rate
2.
#2: Focus on Multiple indicators
3.
#3: focus on inflation

1. Nominal anchor (CPI) method: Benefits/Advantages of
2. Nominal anchor (CPI) method: Drawbacks/Limitations/Anti-arguments
3. Why Target inflation?

1.
Nominal vs Real interest rate
2.
Nominal Anchor (CPI): the 4% Target
3.
Nominal Anchor CPI 4%: WHEN to reach?
4.
Nominal Anchor CPI 4%: How to reach?
4. Hawkish trend: Why interest rates will rise?

5. Mock Questions
Prologue
This article wont make much sense, unless youre thorough with the concepts of monetary
policy: its functions, tools and limitation. So make sure youve read the previous article. click
me (http://mrunal.org/2014/01/banking-monetary-policy-quantitative-qualitative-toolsapplications-limitations-msf-laf-repo-omo-crr-slr-revisited-before-upcoming-urjit-article.html).
Place: RBIs Main Adda @Mumbai
Time: September 2013
Boss: Rajan has recently taken charge as the new governor of RBI. Immediately he setups
three Committees:
(http://www.flickr.com/photos/97816112@N02/12268369415/)
Chairman
Occupation
in RBI
Topic
Result
Bimal
Jalan
Retire
Governor
New Bank
licenses
Work in progress.
Board
member
Financial
products/
Financial
inclusion
Published report in January 2014.Discussed in

earlier articles.
(http://mrunal.org/2014/01/banking-nachiketpanel-universal-electronic-banking-accountueba-payment-access-points-financial-inclusionseigniorage-and-more.html)
Deputy
Governor
Monetary
policy
framework:
how to
strengthen
it?
Published report in Jan14. This is the topic of

our article.
Nachiket
Mor
Urjit
Patel
Urjit Patel Committee: Basics

1. Formed by: RBI (and not finance ministry)
2. Official name: Expert Committee to Revise and Strengthen the Monetary Policy
Framework
3. Chairman: Dr. Urjit Patel, Dy. Governor of RBI
4. Eight Members: economics professors, finance experts etc. Theyre not important for
exams, because No high profile members. [may be because Nachiket took away all the
high profile members like Shikha Sharma of Axis bank
(http://mrunal.org/2014/01/banking-nachiket-panel-universal-electronic-banking-accountueba-payment-access-points-financial-inclusion-seigniorage-and-more.html#1), so Urjit
bhai was left with only chillar parties.]
Overall, Urjit Patels main recommendations can be summarized in just three lines:
1. @Rajan, you fight inflation. [Nominal anchor, 4% CPI and everything]

2. @Rajan, you fix accountability in your own gang. [form MPC Committee, decisions by
voting etc.]
3. @Chindu, you give cover-fire to Rajan, while he is fighting inflation. [fiscal consolidation.]
Lets start with first recommendation.
Urjit
My first recommendation is that RBI must target inflation only. Nothing elsedont focus on increasing employment, dont focus on increasing growth, dont
focus on stabilizing rupee-dollar exchange rate. Just focus on one thing and one
thing only- Inflation.
Mohan
But why focus on inflation only?
Urjit
Observe.
Monetary Policy: Where to focus?
There are three main ways to frame monetary policy
1. Focus on Exchange Rate
2. Focus Multiple indicator (GDP, IIP, Exchange rate, inflation)
3. Focus on Inflation (started in 80s)
Lets check the pros and cons of each strategy.
#1: Focus on Exchange rate

If RBI adopts this strategy/method to frame monetary policy then- what will happen?
Rajan will first decide an ideal target exchange rate say 1$=Rs.50.
Then hell try to amend monetary policy to control rupee supply in the market.
To put this in technically incorrect example: Imagine dollars are apples.

Prices of apple vs Rupee are decided by laws of supply and demand.
At present 1 apple sells for Rs.60. But Rajan wants to bring it 1 Apple=50 rupees. What
should he do?
1. Rajan will tweak his monetary policy to reduce the supply of rupee in the market. Then, 1
apple will sell for Rs.50. (apple supply is same but rupee supply is decreased.)
2. Alternatively, Rajan will open his own refrigerator (forex reserve), and put some apples
(dollars) for sale. Thatll also bring down prices of 1 apple =50 rupees. (because apple
supply increased)
Advantages/Bene ts of targeting Exchange rate?

1. Prices of imported goods are kept in check.
2. Prices of imported crude oil is kept in check. (so indirectly inflation is kept in check).
3. Since exchange rates are kept stable- both importers and exporters can decide their
business expansion plans accurately. (compared to a situation where exchange rate is
volatile-say today $1=40 Rs. And tomorrow $1=60Rs. Then it is not good for business
decisions.)
4. Clarity. Transparency in Decision Making. Aam Juntaa can understand what RBI is trying to
accomplish and whether Rajan is succeeding or failing? (if they ever get free after
watching cricket matches, Saas-Bahu serials and (un)reality shows.)
Disadvantages/limitations of targeting Exchange rate?

1. This method works well to control (imported) fuel inflation. But cannot control (local) food
inflation.
1. Works well for a small countries. Because their population is small, they can even import
food from India, China and just focus on export competitiveness in electronics and
consumer goods. e.g. Singapore, Taiwan etc.
2. But Doesnt work for large countries like India, Mexico or Brazil. Our population is so
large, we cannot sustain on imported food. We must be self-reliant in food production.
3. Country becomes vulnerable to external shocks. Continuing the previous example of
Apple vs Rupee
1. What if American RBI tightens their own monetary policy to control local American
inflation (= US Feds follow a dear money policy =dollar (apple) supply is reduced.)
2. Then Rajans statistical projections will go wrong. Hell have to make new adjustments
in Rupee vs Dollar (Apple) quantity in Indian market.
4. Government is bogus, and causes high food inflation. Result= Real interest rates become
negative, Juntaa will start investing more in gold=>Gold import increased=>payments
have to be made in Dollar. This also creates imbalance in supply-demand of rupee vs
Dollars (Apples). Rajan will have hard time controlling this mess.
5. Country becomes vulnerable to Speculative attacks. e.g. Forex traders in Europe or China
decide to hoard Apples (dollars) in their refrigerator to create artificial shortage in market,
so later then can sell their apples @higher rate. In such speculative attacks, Rajan will
have hard time controlling supply-demand of Rupee vs dollars. He cannot prosecute
them under FERA/FEMA laws, those traders live outside his jurisdiction.
6. Outdated: During WW1 era, most central banks used to follow this Exchange rate
targeting strategy. But today, almost all banks in developed countries, have shifted to
inflation targeting strategy. Only few exceptions- like Singapores RBI use this strategy.
Moving to next method/strategy
#2: Focus on Multiple indicators

At present, this is the strategy RBI uses for making monetary policy.
Under multiple indicator method, Rajan will first gather information about:
1. Index of industrial production (IIP), Consumer confidence
2. Professional forecasts (CRISIL, S&P, Moody, World Bank) about GDP, inflation,
unemployment
3. Inflation data: WPI minus food, fuel.
Then, he will design the monetary policy (mainly repo rate), with following objectives/focuses:
1. Increase employment
2. Increase GDP
3. Stabilize inflation
4. Stabilize exchange rate
Sounds fair enough? Not really!
Multiple indicator method: Negative points/ Limitations
1. Multiple indictor method has no nominal anchor- no actual target. What exactly are you
trying to accomplish? Bring down WPI by 5%, raise GDP to 9%..no such targets. Just bol-
bachhan. Therefore ineffective.

2. Multiple indicator strategy worked well between 1998 and 2008. GDP was good and
inflation was kept in check. But in recent times, this strategy is no longer workinginflation has skyrocketed and GDP is falling day by day.
3. Since 2008, Consumer price index rose to double digits (i.e. 10% or more)
4. But RBI doesnt focus on CPI. They only focus on WPI (minus food and fuel). Result?
a. WPI doesnt track changes in the service sector related inflation (e.g. doctor,
physiotherapist, IT, call center etc.)
b. Service sector contributes more than 60% of GDP. So, when monetary policy is
designed without considering service sector inflation=then itll be ineffective.
5. WPI commodity list has been revised in recent times- they added ice cream, oven, cricket
ball, guitar and so on. Result?
a. RBI has to make new statistical calculation about each of such busines arenasnumber of people employed in it, total bank loans given, their contribution to GDP etc.
b. But when WPI commodity list is revised, RBI has to calculate new statistical
projections= problem. Policy doesnt give effective result in the meantime.
6. Even if Rajan makes best policy, its Impact will be seen after a lag of 3-4 quarters (i.e. nine
to twelve month). Why? We already learned the limitations of Monetary policy in a
developing country, the past article. Click me (http://mrunal.org/2014/01/bankingmonetary-policy-quantitative-qualitative-tools-applications-limitations-msf-laf-repo-omocrr-slr-revisited-before-upcoming-urjit-article.html#991)
7. Since this strategy doesnt have a clear cut transparent targets, it becomes vulnerable to
various pressure groups. For example
Pressure
group
informally forces Rajan to:

Please increase SLR ratio. That way government is able to sell more of its
securities to the banks and- arrange cash from more schemes to
increase employment- after all thats what you want- increase
Chindu
employment!
Secondly, please increase the quota for women under Priority sector
lending because Rahul baba has been advocating women
empowerment everywhere, including @Arnab Goswamis interview.
Exporters/
IT
companies
Importers
Rajan Bhai, please tweak your monetary policy in such way that
$1=becomes 1000 rupees, then we earn more rupees while exporting
goods n services abroad.
Please design your monetary policy in such way that $1 = Rs.1. then
weve to spend less rupees while importing stuff from abroad.
Please decrease Priority sector lending, CRR and SLR that way more
FICCI
money is left for business loans for corporate giants.
Maai baap, please reduce PSL targets, SLR, CRR and Repo, that way more
Bankers
money is left with us, and we can lend it to middle class and
businessmen.
Therefore, Urjit recommends Rajan to dump this multiple indicator method.

Ok boss. So far Ive learned following:
1. Monetary policy should not focus on exchange rate because our country is
very large, unlike Singapore and Taiwan.
Mohan
2. Monetary policy should not focus on multiple indicator approach, because

of the limitations we just saw in above paragraph.
Then what is your solution?
Urjit
Simple. Focus on inflation
#3: focus on in ation

In this strategy- Rajan will decide a Nominal Anchor say CPI -to monitor inflation. Then hell
fix an inflation-target say 2-6% and adjust his monetary policy so that inflation remains within
that range.
Nominal anchor (CPI) method: Bene ts/Advantages of

1. Once Rajan sets a CPI target. Noone can influence him or put informal pressure- be it
Chindu, Exporters, Importers, FICCI, Mallya, Ambani or Bankers cannot influence Rajans
policy. Because Rajan
2. Easy to track progress. Because CPI data released after every twelve days.
3. Central banks in all advanced economies and Emerging market economies have adopted
this method. (Except India and China).
4. It brings transparency. Even aam-juntaa can understand what RBIs policy is and whether
its yielding result or not? Because there is only target to monitor=CPI.
Previous Committees have also directly/indirectly recommended for this system. For
example:
year
Committee
Chairman
2007
Mumbai as International Finance Center
Percy Mistry
2009
Financial sector reform
Rajan the Boss

himself
2013
Financial Sector Legislative Reforms Commission

(FSLRC)
BN SriKrishna
Nominal anchor (CPI) method: Drawbacks/Limitations/Anti-arguments

Mohan
Hold on a second. Youre trying to paint a very rosy picture. But if Rajans
monetary policy tries to control CPI, itll have many problems!
Urjit
Such as??
In CPI index- more than 50% weightage is given to food and fuel components.
Food prices= depend on monsoon and blackmarketers. Rajan has absolutely
Mohan
zero control over this.

Fuel/crude oil prices= depend on external factors and Rupee-Dollar exchange
rate. Rajan doesnt have sufficient forex reserves to control rupee-dollar
exchange rate in the manner he wants (e.g. 1$=50 rupees and not 1$=60 Rs.)
Youre right. But under multiple indicator method, Rajan focuses on WPI
(minus food and fuel inflation).
Urjit
Thats why his policy has remained ineffective in controlling inflation.Because

he always ignored food and fuel inflation.
Infact, We must focus on CPI for the very same reason-because it give >50%
weightage to the food and fuel inflation.
Mohan
Point taken. But in India, we have three CPIs: Urban, Rural and Combinedif we
try to control all three of them, then..
Urjit
No problem. We must focus only on CPI (Combined). Its data is released @every
12 days. Very easy to monitor, tracks price movement all over India.
Mohan
Ya but still, Its data is not accurate and.
Urjit
yaar if you start to find fault in everything (like a TheH**** columnist), .then
only God can help you. Fidel Castro and Che Guevara cannot fix Indias inflation
problem. This only gets fixed from inside the RBI!
Mohan
But even if Rajan focuses on this Nominal Anchor (CPI), still there will be a lag of
6-8 months before its impacts are seen.
Brother, no matter which method we use there will be lag of 6-8 months before
its impact is seen on inflation @ground level.
Urjit
Because we are not a developed country, we are a developing country.

Weve already learned this limitation of monetary policy in developing
countries. Click me.
Mohan
Ok one last obstacle. Governments own policy to fight CPI. For example,
whenever prices of sugar, onion or pulses get very high, the government
arbitrarily puts export ban on those commodities, start importing them from xyz
country, starts distributing them @subsidized rates in various cities.
Urjit
So?
Mohan
So Rajan may be designed his policy to fight CPI using abc statistical projections
but at random, the government will do xyz policy on its own to fight inflation=
Rajans statistical projections will become wrong and his monetary policy will
become #EPIFAIL.
Urjit
For this I recommend better coordination and data sharing between

Government of India and RBI, regarding inflation control.
Why Target in ation?

Mohan
Im still not clear. Why should Rajan only focus on inflation (CPI). Other things are
also important like GDP, IIP, employment, investment, exchange rates. why
focus on CPI only, and ignore everything else?
Urjit
let me explain:
petrol and onion prices, hardship to middleclass= those are clichd points. Lets learn some
new points.
In recent years, Indias inflation has been highest among all G20 countries.
Indias inflation has been higher than its trade competitors.
CPI
2008
2012
World
Brazil
China
<3
India
>10
S.Africa
11
Russia
14
From above table, you can see that

Between 2008 to 2012- China, South Africa and Russia have drastically reduced their
inflation. Only India is the #EPICFAIL country where inflation has increased- instead of
decreasing!
Higher inflation = real interest rates decreased => makes people buy more
gold=>CAD=>rupee weaken=>petrol expensive=>everything expensive=>every more
inflation =vicious cycle.
Mohan
Whoa, whoa, whoa man slow down. What is real interest rate? How does it affect
economy?
Nominal vs Real interest rate

Urjit
Suppose Ive 100 rupees. But instead of buying onions, I put this money in a savings
account.
Observe what happens with my purchasing power:

Onion Rs./kg
Money
How much can you Buy?
1st Jan
20
100
5 kg
31st Dec
100
104
~1 kg
Meaning, although bank increased your money from Rs.100 to 104, but you can buy very less
onions. Therefore, we must not focus on nominal interest rate i.e. 4% but on real interest
rate.
Bank deposit
Nominal Interest
Rate
CPI
(Inflation)
Real Rate of Interest=(NominalInflation)
Savings
account
4.00%
11%
-7%
Fixed
deposit
9.00%
11%
-2%
From above table, you can see Banks in India offer negative real interest. Therefore, people
prefer to invest in gold, instead of putting money in bank accounts.
Result:
Excessive gold import=>Current account deficit increased=>Rupee Weaken
=>Petrol/diesel expensive=>even more inflation. This becomes a vicious cycle where you
cannot find whether hen came first or the egg came first?
When people invest money in gold, instead of putting it in bank=> businessmen get less
loans=>less expansion =>less jobs=> less growth in GDP.
Now if you compare India vs [China, Russia, South Africa]. You can see- their inflation is
low=> real interest rate would be higher => people invest less in gold=> more money
flows towards banks=>business loans=>higher GDP, higher IIP (index of industrial
production).
Urjit
In other words, when Rajan frames monetary policy, he should only fight against
inflation then low GDP, low IIP will be fixed automatically.
Mohan
fair enough.
Nominal Anchor (CPI): the 4% Target

Ok far weve learned:
When Rajan frames monetary policy
1. He must focus on fighting inflation only.
2. To fight inflation, he must focus on CPI.
Now the problem? What should be his exact CPI target? 4%, 5%. 0%, -50%??
Mohan
This is easy. Rajan should design monetary policy in such way, that CPI is -50%. If
bottle of desi liquor was sold @100 Rs. in 2010, then in 2014 its price should
reduce to Rs.50 only. Then Maujaa hi Maujaa.
Urjit
I hate to break your spirit, but such deflationary trend is not good for economy.
Every business has fixed cost of production minimum light bill, phone bill, office rent,
staff salary etc. So, if prices keep falling and falling, then businessman will suffer losses.
He has no motivation to expand business. He wants to cut down his production costs, by
firing some of the employees= less new jobs created= unemployment = social unrest.
If prices of everything fall- then custom duty, VAT, excise duty, service tax- their collection
will also decrease. Then government has less money to spend on education, healthcare,
social sector, defense, law and order = poverty, disease, crime.
Mohan
Then what should be the minimum target? What should be the lower limit of
inflation?
Urjit
Minimum 2% inflation is necessary in any economy.
Mohan
Then what should be the maximum limit for inflation/CPI?
Urjit
Ive analyzed data from various countries. When CPI gets higher than 6.2%, it
negatively affects GDP and employment. Therefore Rajan should ensure CPI
inflation doesnt cross more than 6%.
Mohan
Ok, minimum 2% and maximum 6%.

Right RBI should try to get CPI inflation @4% with band of +/-2%.
Urjit
meaning 4-2=2% minimum

and 4+2=6% maximum
Mohan
But why give this 2% band? Why not just say 4% is our target?
Because in real life, it is not possible to get inflation controlled @exactly 4%
level. There will be unanticipated price shocks in food and fuel items, wars,
Urjit
famines and natural disasters.

Therefore, Rajan should be given some room to accommodate such shocks
thats why 2-6% target.
Besides, the RBIs of other countries also use similar band method: observe
Central Bank of
CPI target under their monetary policy
Mexico
2-4%
South Africa
3-6%
Israel
1-3%
Chile
2-4%
So, its a tried and tested method. we should follow the same.
Nominal Anchor CPI 4%: WHEN to reach?

Ok so far Ive learned:
Mohan
Urjit Patel Committee wants to strengthen monetary policy framework

You insist RBI to fight inflation only.
You even gave Rajan a target: 4% CPI (Combined), with +/-2% band
Urjit
That is correct.
Mohan
well, Your recommendation is ambitious, but unrealistic. I repeat again- There

are many factors outside Rajans control like monsoon and black marketers. I
dont think Rajan can ever bring down inflation to 4% level.
Urjit
It is possible. Let me give you the case study of Chile.
During 90s, Chile was facing CPI inflation as high as 25%.
But in the early 2000s, the RBI of Chile made the target 3% CPI (With +/-1% band)=2-4%
CPI
Now observe the following graph- particularly the green band between 2002 to 2006. You
can see Chiles RBI has successfully managed to contain inflation within that 2-4% level.
Urjit recommended following timeframe:
0 month (i.e. when Urjit was

making report)
CPI is ~10%
Within 12 months
RBI should reduce CPI to 8%
Within 24 months
RBI should reduce CPI to 6%
Then
Just try to maintain inflation within the 2-6% range. (i.e.

4% with +/-2% band)
In short: 0/12/24 (months)=>10/8/6 (CPI)
Nominal Anchor CPI 4%: How to reach?

Mohan
Urjit
Alright. If Chile can do it, we can also do it. But HOW?

Using the same tools available in the present monetary policy framework.
Especially the policy rate.
Mohan
What is policy rate?
Urjit
Repo rate under Liquidity adjustment facility (LAF)= thats our policy rate.
And reverse repo(RR) = Repo minus 1%;
MSF=Repo +plus 1%
Urjit
^This system is fine. I recommend that Rajan should continue with it.
RBI should not change this +/- 1% spread between RR-Repo-MSF. (unless in
extreme situation) because unpredictable policy making= not good for
banking sectors own business plans and tactical projections .
Hawkish trend: Why interest rates will rise?
Ok so far Ive learned:

Urjit Patel Committee wants to strengthen monetary policy framework
Mohan
You insist RBI to fight inflation only.

You even gave Rajan a target: 4% CPI (Combined), with +/-2% band
You even gave Rajan a timeframe: 0/12/24 (months)=>10/8/6 (CPI)
You even gave Rajan the firing strategy: fight inflation via Policy rate (Repo
Rate)
Urjit
That is correct.
Mohan
But then whats the new story my friend? All these years, RBI has tried to fight
inflation by using Repo rate as its policy rate. But it has failed to yield any
positive result. What makes you think repo rate can fix our inflation problems?
Urjit
Swami Vivekanand has said Aim higher. On the same logic, I recommend Repo
Rate should be kept higher than CPI. Then itll fix the problem.
Observe.
At present
Repo
8%
CPI
~10%
Difference (Repo MINUS CPI)
-2
You can see Repo rate is lower than CPI. Thats why its ineffective. In the previous article on
monetary policy, we learned that
Monetary policy Tool
How to Fight inflation?
How to fight deflation?
Repo rate
Increase repo rate
Decrease repo rate.
Therefore, to fight inflation repo rate MUST be increased. Urjit Patel recommends that Repo
rate should be increased so much that its higher than CPI.
At
present
Urjit Patels recommendation
Repo
8%
Should be higher than CPI. Here CPI=10, so lets keep

Repo @11%
CPI
~10%
~10
Difference(Repo
MINUS CPI)
-2
(11-10)=+1
In other words, Urjit Patel recommends that difference between Policy rate (Repo rate) and
CPI should be positive, Only then Policy rate can fight inflation.
What will be the consequences of high repo rate?
Banks borrow less from RBI (Because theyve to pay more interest rate)
Banks will increase their loan interest rates (because theyve less new money and still
want to keep profit margin same)
Less business expansion (because less people take loans, due to higher interest rate)
Less new jobs created
Less income
Less demand
Sellers will reduce Prices of goods and services, to attract and retain customers.= inflation
reduced.
Mohan
Wait wait wait. Urjit Patel, youre a hawkish person, a person who believes
inflation can be fought by increasing the interest rates.
Urjit
So what?
So manRajan raises Repo rate=>SBI increases loan interest rates=>harder
to borrow for businessmen=>less business expansion =>less new
Mohan
jobs=>deflationary trend=>this will hurt our GDP.

CRISIL, Moody and other experts have made statistical projections- that even
in 2015, our CPI will be ~8.5%. So by your logic, Rajan should keep Repo @9%.
It will kill the growth!
Theoretically youre right. High interest rates are not conductive for higher
GDP growth.
But Indian inflation has become so high, that extreme steps are necessary.
Urjit
Besides, the RBIs of Australia, Canada, S.Africa, Mexico, Brazil, Israel all
have taken same measure in past.

When inflation became very high, they raised repo rate to level higher than
inflation. Only then problem was fixed.
Mohan
Whatever man. Im going to write a column in TheH**** to criticize you that If

Urjit Patel Committees report is implemented, interest rates will rise and growth
will be killed. (Packs his laptop and Prepares to leave.)
Urjit
WAIT! Picture abhi baaki hai mere dost. Overall I made three important
recommendations. In this article we only learned the first one:
1. @RBI fight inflation

a. Target=4% CPI, +/-2% Band [=control inflation in 2-6% range.]
b. Tool=Repo as policy rate, +/-1% spread in RR-Repo-MSF,
c. Time limit: 0/12/24 (months)=10/8/6% (CPI)
d. Strategy=keep repo higher than CPI.
2. @Chindu, give cover fire to Rajan, while he is fighting inflation (=in next article click me
(http://mrunal.org/2014/02/economy-urjit-patel-committee-fixing-accountability-in-rbimonetary-policy-committee-decision-by-majority-fiscal-deficit-part-2-of-2.html))
3. @Rajan fix accountability in your gang. (=in next article click me
(http://mrunal.org/2014/02/economy-urjit-patel-committee-fixing-accountability-in-rbimonetary-policy-committee-decision-by-majority-fiscal-deficit-part-2-of-2.html))
Mock Questions
1. Incorrect statement
a. Nominal interest rate doesnt take inflation into account.
b. Real interest rate doesnt take Nominal interest rate into account.
c. Both A and B
d. Neither A nor B
2. What do you understand by Real interest rate?
a. Nominal interest rate plus inflation
b. Nominal interest rate minus inflation
c. Nominal interest rate multiplied with inflation
d. None of above.
3. In a futuristic society, if Real interest rate became a positive number, which of the
following is most likely to be correct?
a. Fiscal deficit increased at the expense of current account deficit.
b. People have started putting their entire savings into gold.
c. RBI and Government failed in combating inflation.

d. RBI and government successfully managed to bring down inflation below the nominal
interest offered in banks.
4. Urjit Patel Committee has observed that
a. CPI lower than 2% is good for economy but CPI higher than 6% is bad for economy
b. CPI lower than 2% facilitates growth but CPI higher than 6% reduces employment.
c. CPI lower than 2% and higher than 6%, are bad for GDP and employment.
d. None of above.
5. Urjit Patel Committee has recommended that
a. RBI should continue with multiple indicator method to frame monetary policy, while
targeting 4% inflation.
b. RBI should ignore fuel, food and service sector inflation and focus on core inflation
only.
c. RBI should frame monetary policy while keeping CPI as the nominal anchor.
d. None of above.
6. Urjit Patel recommends RBI to:
a. Bring down consumer price index inflation to 6% within next twelve months.
b. Switch its focus from multiple indicators to exchange rate stabilization
c. both A and B
d. Neither A nor B.
7. To Combat inflation, Urjit Patel Committee has recommended RBI to:
a. Keep Repo rate lower than CPI.
b. Keep Reverse repo rate higher than MSF.
c. Keep the value of Reverse repo rate between Repo rate and MSF.
d. None of Above.
Q8. If RBI frames monetary policy with primary objective of stabilizing the exchange
rate, what will be the consequences?
1. Country becomes vulnerable to shocks emanating from the country to which its currency
is pegged.
2. Country becomes immune to speculative attacks in forex trading market.
3. Imported inflation will be kept in check.
Choices
a. Only 1 and 2
b. Only 2 and 3
c. Only 1 and 3
d. All 1, 2 and 3.
Q9. What are the recommendations of Urjit Patel Committee?
1. Ination should be the nominal anchor for the monetary policy framework.
2. RBI should adopt the new CPI (rural) as the measure of the nominal anchor for policy
communication.
3. WPI ination should be set at 4 per cent with a band of +/- 2
Answer choices
a. Only 1 and 2
b. Only 2 and 3
c. Only 1 and 3
d. Only 1
Q10. Match the following:
I. Hawk
II. Bull
1. Purchases securities under the assumption that they can be sold later at a
higher price.
2. Believes that a particular stock or the market as a whole, is headed for a
fall in prices.
III. Bear
3. Favors relatively high interest rates in order to keep inflation in check.
4. Favors relatively low interest rates in order to keep deflation in check.
Answer choices
Options
II
III
Q11. Match following
I. Nachiket Mor
1. Nominal Anchor Method to frame Monetary Policy
II. Urjit Patel
2. Financial Sector Legislative Reforms
III. BN SriKrishna
3. Governance of Boards of Banks in India.
IV. P. J. Nayak
4. Financial products for small businessmen.
5. State backwardness index
Answer choices
Options
II
III
IV
Mains / interview type questions, once we finish remaining recommendations of the

committee in next article.
MCQ hints:
1. incorrect statement is B
2. technical formula is bit different- but here opt B
3. last one
4. <2 and >6 both bad.
5. second last
6. neither
7. none
8. second statement is wrong.

9. only first statement is right
10. hawk-interest, bull -will rise; bears-will fall
11. Nachi- products, Urjit- Nominal, BN-reforms, Nayak-Board.
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So far 101 Comments posted
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REPLYTOCOM=143943#RESPOND)
Sree
where is part 2.?. waiting for that
Mrunal (http://mrunal.org)
Part 2 of the article has been published. Click me ([Economy]

Urjit Patel Committee: Fixing Accountability in RBI, Monetary
Policy Committee, Decision by Majority, Fiscal Deficit (Part 2 of 2))
REPLY (/2014/02/ECONOMY-RBI-URJIT-PATEL-COMMITTEE-4-CPI-NOMINALANCHOR-MULTIPLE-INDICATOR-MONETARY-POLICY-FRAMEWORK-REFORMSPART-1-OF-2.HTML?REPLYTOCOM=148521#RESPOND)
NIKHILESH
dada,why cpi less than 2% bad for economy.
Abhay
this link cannot be accessed
Ganesh Babu S
Mrunal,
Its a personal suggestion. It will be great if you can share the source of
the articles posted too. If I am right for this article you have researched
the editorial Inflation Targeting:A Controversial Shift in EPW along
with other sources. Giving the source address can definitely be helpful
if someone wishes to further enhance his knowledge.
Thank you
pradeep
@babu: doing phd in these topics is not necessary n dont get

offended plz
Rinu
Urjith Patel is boring
You presented it very well Though Admin
ashish
dude.. you rock
Mohit
Hats off Mrunal, to the way you use innovation and to the way you
present! Keep up the good work!
Rohit
Hi Mrunal,in your last article you have written that repo rate wud nt be
that effective to control inflation as banks does not depend largely on
RBI for their money requirement,instead they(banks) tend to fulfill
their money need from saving accounts and fixed deposite accounts
then how come this strategy of controlling inflation thru repo rate wud
work???plzzz reply
Sunny
Same doubt. Rohit did you find something regarding this??
ashish
thats why time frame of 0/12/24 is given because it takes
time to respond in developing country..
madhu
1)2
2)2
3)4
4)4
5)3
6)4
7)4
8)3
9)4
10)D
11) I THINK OPTIONS WERE NOT FRAMED IN PROPER
MANNERPLEASE CORRECT ME IF I AM WRONG
akshat mittal
can i download pdf version of thee articles..??
vineesh
Excellent work !! U give a wider perspective in a decent way! Thank yu!
Jai hind
mithles
Before readind this article, i was not interested in economy but the
way you have delt this Urjit I become intested, sochta hu, if I you had
my mentor I would prefer to opt Economy for mains .You know how to
teach, thanks.
Arjun
CPI is not released every 12 days , It is released on 12th of every
month, providing provisional data for month preceding and confirmed
data of the month preceding the said month.
REPLY (/2014/02/ECONOMY-RBI-URJIT-PATEL-COMMITTEE-4-CPI-NOMINAL-ANCHOR-
MULTIPLE-INDICATOR-MONETARY-POLICY-FRAMEWORK-REFORMS-PART-1-OF-2.HTML?
sunil
Very nice explanation
raghupurimetla
awesome article sir, wonderful explanation thanq very much
Amarnath
Mrunalji thank you for a providing simple and useful articles.
I have a doubt You are saying increase in REPO rate finally reduces
prices of the commodities but what about the inelastic goods like food
and fuel. you said in the post more than 50% weight-age in cpi given to
food and fuel. plz clear my doubt. once again thanking you ji.
Pranav Joshi
Mrunal da please budget 2014 pe bhi articl post karo na, apne andaaz
mein!!
Shijoy Varughese
Mrunal..CPI rural urban and combined were mentioned here.But does
not India have 4 CPI s(UNME,QL,IW &RL)..Are they the same!
SD
keep going..u r guruappreciate all ur explanations..
SHOAIB
WHAT IS REMUNERATED STANDING FACILITY?HOW WILL IT WORK AND
WHY SOME PEOPLE OPINED THAT IT WOULD BE DETRIMENTAL TO THE
RBI BALANCE SHEET?
SHOAIB
ANOTHER CONFUSIONWHEN URJIT PATEL SUGGESTED FOR
THE EXCLUSION OF FUEL N FOOD ARTICLE WHY HE RECOMMENDED
CPI TO BE THE NOMINAL ANCHOR OF MONETARY POLICY WHICH
GIVES MORE WEIGHTAGE TO THESE ITEMS?
avinash niraj
very well sirit is so lucid.
vinn
Cover fire!!
lol
awesome.
Satyajeet Nayak
In your answer for question No. 8, you have given option 2 as
wrong.But in the theory portion, you have mentioned the option 2 also
as a possible consequence.So, should not the answer for question 8 be
all are correct?
rahul
Innovative way of making easy thing look boring ..
Gourav Soni
very nice articlemrunal sir.hats off to the way you made so many
topics so interesting
Raghubeer
This article is really one of the very best of ur works Mrunal! Especially
the Rajan line in the beginning had me floored! I have prelims in 2
days! Ahemmm THanks a ton!!!
Suneet
sir bahut lamba article hai.. chakar aa rahai hain.
deepa gupta
awesome sir rilly makes economics more intresting:-)
arul daniel
could you explain financial sector legislative reforms commission sir,
kumar
Sir, Ive a doubt. If inflation is because of structural problems of
economy such as lack of cold chains, apmc act, food processing
facilities etc.. how justified is to put interest rate higher which affects
lending in industry and their invesment as well.
Praveen_R
You are correct RBI cant control inflation due to supply side
bottlenecks and the raising CAD. It just can keep the money off
the shelf to keep the demand low and thus control the prices,
but that takes a toll on the growth.
Thats why Urjit suggested in his 3rd point
@Chindu, you give cover-fire to Rajan, while he is fighting
inflation. [fiscal consolidation.]
satya
bhaiya charan kaha hain aapke?
super duper awesome yaar!
Praveen_R
Hats of Mrunal
@Rajan, you fight inflation. [Nominal anchor, 4% CPI and everything]
@Rajan, you fix accountability in your own gang. [form MPC
Committee, decisions by voting etc.]
@Chindu, you give cover-fire to Rajan, while he is fighting inflation.
[fiscal consolidation.]
never though UPSC preparation can also be so fun
Nikki
Mrunal.the article is really superb,..but i am unable to access part
2 of this article.
unmesh
Its difficult to fight inflation
Neha
again thanksss sir very beautifully explained..!!!
kanhaiya pachisia
u r rock mrunal..keep it up
Gopal singh
i really thnk to u mrunal for giving good conceptual clearty in
economics topic..thnk u..keep it up
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Explained - Urjit Patel Committee On Monetary Policy Reform

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Mrunal (http://mrunal.

[Economy] RBI Urjit Patel Committee: 4% CPI, Nominal Anchor,

Banking (http://mrunal.org/category/economy/banking) / 12 months Ago /

#1: Focus on Exchange rate

#2: Focus on Multiple indicators

#3: focus on inflation

3. Why Target inflation?

Nominal vs Real interest rate

Nominal Anchor (CPI): the 4% Target

Nominal Anchor CPI 4%: WHEN to reach?

Nominal Anchor CPI 4%: How to reach?

4. Hawkish trend: Why interest rates will rise?

Published report in January 2014.Discussed in

Published report in Jan14. This is the topic of

Urjit Patel Committee: Basics

1. @Rajan, you fight inflation. [Nominal anchor, 4% CPI and everything]

But why focus on inflation only?

Monetary Policy: Where to focus?

#1: Focus on Exchange rate

To put this in technically incorrect example: Imagine dollars are apples.

Advantages/Bene ts of targeting Exchange rate?

Disadvantages/limitations of targeting Exchange rate?

#2: Focus on Multiple indicators

Multiple indicator method: Negative points/ Limitations

bachhan. Therefore ineffective.

informally forces Rajan to:

money is left for business loans for corporate giants.

Therefore, Urjit recommends Rajan to dump this multiple indicator method.

2. Monetary policy should not focus on multiple indicator approach, because

Simple. Focus on inflation

#3: focus on in ation

Nominal anchor (CPI) method: Bene ts/Advantages of

Mumbai as International Finance Center

Financial sector reform

Rajan the Boss

Financial Sector Legislative Reforms Commission

Nominal anchor (CPI) method: Drawbacks/Limitations/Anti-arguments

zero control over this.

Thats why his policy has remained ineffective in controlling inflation.Because

Ya but still, Its data is not accurate and.

Because we are not a developed country, we are a developing country.

For this I recommend better coordination and data sharing between

Why Target in ation?

From above table, you can see that

Nominal vs Real interest rate

Observe what happens with my purchasing power:

How much can you Buy?

Real Rate of Interest=(NominalInflation)

Nominal Anchor (CPI): the 4% Target

Minimum 2% inflation is necessary in any economy.

Then what should be the maximum limit for inflation/CPI?

Ok, minimum 2% and maximum 6%.

meaning 4-2=2% minimum

famines and natural disasters.

CPI target under their monetary policy

Nominal Anchor CPI 4%: WHEN to reach?

Urjit Patel Committee wants to strengthen monetary policy framework

well, Your recommendation is ambitious, but unrealistic. I repeat again- There

It is possible. Let me give you the case study of Chile.

0 month (i.e. when Urjit was

RBI should reduce CPI to 8%

RBI should reduce CPI to 6%